RISK MANAGEMENT - WHAT WOULD YOU CHOOSE? 🤑🤑🤑🤑🤑
Hi traders!
Introduction -
I was reading a few articles around risk management, the psychology off a successful trader & common mistakes traders who fail make.
I stumbled across a concept which I thought resonated with me and made me really think about my psychology towards risk management and I thought I would share it with you. I hope this is just as fascinating to you as it was to me, and it has some intrinsic value to you.
Why is risk management important in Trading?
Trading in general can be regarded as a high-risk activity compared to not trading at all which would be regarded as having virtually no risk to any principal money you may have.
For this reason, I would regard risk management to be the most important concept in any type off trading regardless off strategy, instrument & individual ability. Let’s look at the definition of risk management:
“Risk management involves identifying, analyzing, accepting and/or mitigating trading decision uncertainty.” – Yahoo Finance
To summaries we know trading is risky, therefore risk management is a tool to control that risk & staying in control is the most important thing that you must never forget.
This is going to be the reason why the almost 90% of traders fail and why only 10% manage to achieve some sort off “success” from trading and its all to do with risk.
Now I know for sure we can all think back to a time where we fell into this trap, but the important thing is learning from that lesson.
90% of traders will lose more on their losing trades than they win on their winning trades and that’s why they are not in the 10% of “successful” traders
Understanding decision making from winning & losing
Here’s the way it goes:
Say I offered you a very simple wager and that wager was based on the flip of a coin. All you must do is predict whether the coin will land on heads or land on tails. The same principal activity off trading in its most basic form. Will price go up or will price go down?
A simple 50/50 chance off being right regardless of what strategy you use right. Here comes the interesting part, the part that changes everything.
The wager
Say I decide to give you two choices, we will label these option A and option B. Now remember we already know what we’re doing is risky, but our aim is to maximize profit and minimize losing and put our money to work.
Now thinking logically Option A is the one which maximizes our profit (which is our goal). That doesn’t make Option B wrong however as this option means you are guaranteed to make a profit you just aren’t maximizing what you could make. You will not be surprised that in this scenario then more than likely the most popular option is option B. Guaranteed profit with little to no risk. That’s a thumbs up from a risk management perspective.
Here’s where I’ll highlight why 90% off traders fail.
Let’s turn this scenario upside down and on its head and instead of talking making profit lets talk about making a loss.
Now before I fully explain it lets put it into the concept of trading.
Option A – A trade is going against you. Its about to hit your stop loss and you decide that you’re going to move your stop loss into further loss as there is the potential that you can get back to breakeven and you hate losing money.
Option B – A trade is going against you again. Its about to hit your stop loss and you decide that you would rather take the guaranteed loss off -£400 rather than take the risk your loss could exceed.
In the second scenario we all know that option B would be the most sensible option as it means we are managing our risk and staying in control of the situation. Remember as I said that’s the most important thing, stay in control. However unlike in scenario one where we are likely to choose option B when it comes to making money in scenario 2 when it comes to losing money, we seem to become risk driven and would rather roll the dice on losing more money for the chance to get out without losing anything at all rather than take the guaranteed risk.
The scenario shows the reason I think traders lose more than they win and by understanding the simple concept you can give yourself the best possible chance of long-term success. Remember our goal is not to be right in forex, it is to make money. To make money we need to limit our risk and stay in control.
The best way to combat this and to remove the emotional influence is to have predetermined targets. Know where you will get out of a trade; win or lose & don’t allow anything or anyone to influence that pre-determined decision.
Hope this was insightful for you and thanks for reading!
The Fx Chartist
Introduction -
I was reading a few articles around risk management, the psychology off a successful trader & common mistakes traders who fail make.
I stumbled across a concept which I thought resonated with me and made me really think about my psychology towards risk management and I thought I would share it with you. I hope this is just as fascinating to you as it was to me, and it has some intrinsic value to you.
Why is risk management important in Trading?
Trading in general can be regarded as a high-risk activity compared to not trading at all which would be regarded as having virtually no risk to any principal money you may have.
For this reason, I would regard risk management to be the most important concept in any type off trading regardless off strategy, instrument & individual ability. Let’s look at the definition of risk management:
“Risk management involves identifying, analyzing, accepting and/or mitigating trading decision uncertainty.” – Yahoo Finance
To summaries we know trading is risky, therefore risk management is a tool to control that risk & staying in control is the most important thing that you must never forget.
This is going to be the reason why the almost 90% of traders fail and why only 10% manage to achieve some sort off “success” from trading and its all to do with risk.
Now I know for sure we can all think back to a time where we fell into this trap, but the important thing is learning from that lesson.
90% of traders will lose more on their losing trades than they win on their winning trades and that’s why they are not in the 10% of “successful” traders
Understanding decision making from winning & losing
Here’s the way it goes:
Say I offered you a very simple wager and that wager was based on the flip of a coin. All you must do is predict whether the coin will land on heads or land on tails. The same principal activity off trading in its most basic form. Will price go up or will price go down?
A simple 50/50 chance off being right regardless of what strategy you use right. Here comes the interesting part, the part that changes everything.
The wager
Say I decide to give you two choices, we will label these option A and option B. Now remember we already know what we’re doing is risky, but our aim is to maximize profit and minimize losing and put our money to work.
Now thinking logically Option A is the one which maximizes our profit (which is our goal). That doesn’t make Option B wrong however as this option means you are guaranteed to make a profit you just aren’t maximizing what you could make. You will not be surprised that in this scenario then more than likely the most popular option is option B. Guaranteed profit with little to no risk. That’s a thumbs up from a risk management perspective.
Here’s where I’ll highlight why 90% off traders fail.
Let’s turn this scenario upside down and on its head and instead of talking making profit lets talk about making a loss.
Now before I fully explain it lets put it into the concept of trading.
Option A – A trade is going against you. Its about to hit your stop loss and you decide that you’re going to move your stop loss into further loss as there is the potential that you can get back to breakeven and you hate losing money.
Option B – A trade is going against you again. Its about to hit your stop loss and you decide that you would rather take the guaranteed loss off -£400 rather than take the risk your loss could exceed.
In the second scenario we all know that option B would be the most sensible option as it means we are managing our risk and staying in control of the situation. Remember as I said that’s the most important thing, stay in control. However unlike in scenario one where we are likely to choose option B when it comes to making money in scenario 2 when it comes to losing money, we seem to become risk driven and would rather roll the dice on losing more money for the chance to get out without losing anything at all rather than take the guaranteed risk.
The scenario shows the reason I think traders lose more than they win and by understanding the simple concept you can give yourself the best possible chance of long-term success. Remember our goal is not to be right in forex, it is to make money. To make money we need to limit our risk and stay in control.
The best way to combat this and to remove the emotional influence is to have predetermined targets. Know where you will get out of a trade; win or lose & don’t allow anything or anyone to influence that pre-determined decision.
Hope this was insightful for you and thanks for reading!
The Fx Chartist