Talking a litle bit about Risk management Part 1

Recent conversation made me want to talk about risk management. At this point I need to address that risk management comes with money management (for more about this see here). But today I want to focus on risk management alone. 

There are many forms of risk management. Let me briefly describe what risk management is. Risk management is the process to identify (and in many cases the “attempt” to control) threats to a company or to assets of a company. While big companies have (more or less strict) regulations about risk management, we retail traders do not have any regulations on risk management. Let me now transfer this to the retail trader.

Risk management basically covers the decision process where to exit a position (if the decision is in favour of taking the respective position). Stops are a tool to help close a position. There are different forms of stops, such as hard stops, trailing stops, and mental stops. Each of them have their very own advantages and disadvantages. Traders who use mental stops are afraid that the broker (market maker) will influence the price to trigger their stops. If there is no stop, the market maker won’t be able to trigger their stops. Hence their trade is safe from getting hunted, while those traders that use hard stops can become victim of this practice of stop hunting. (Click here for more about stop hunting)

Keeping a mental stop however requires guts of steel. Traders who use mental stops need to have a strong mind, because humans are fast in changing their minds. The factor fear and greed make us do things that we would not do under normal conditions. Have you ever looked at a chart and then asked yourself “How could I have done this?” or “Why in the world did I exit the trade here?”

If you ask me how I manage risk, the answer is simple. I never take a position without a stop. I know very well, that there are many professionals making a big chunk of money by hunting stops. But I rather get stopped out than give the market a chance to take more of my money. I just have to locate the levels and be patient. There is no guarantee in trading. We will all have losses. We just need to be wise with our stops. My stops are always technical. There is no minimum or maximum distance requirement for my trades. If my money management allows me to take the trade and use the technical sound stop, I take the trade. If not, I wait for the next opportunity.

There are traders who like to keep their stops very close to their entries. This is a sound strategy. The downside of this strategy is the chance of getting stopped out. But this should not bother you at all, as you did decide before your entry that you do not want to be part of the move if price reaches a certain level. There should not be hard feelings about getting stopped out. (read also the following articles Do you mind a losing trade?, Ist ein Verlust-Trade schlecht?)

I like to incorporate market structure in my decision process. My stops always depend on the type of trade and the type of entry. Intraday trades are managed differently, while swing and or position trades are managed differently. Intraday trades follow a tailing stop, while swing and position trades are closed manually after having put the stop to breakeven. It is essential that you know before you enter what type of trade you are planning to trade.

I hope you enjoy my post. If you have any questions or suggestions please leave them in the comments section below.

Happy trading,

TT