Today’s lesson is going to be a little about trading psychology and a little about money management. At the end of this post we have provided additional training videos to further enhance your skills. We are going discuss what risk is and how most traders view it from the wrong perspective.
First, let’s cover a couple of definitions:
- Money management is how much capital you are going to put at risk for a trade.
- Risk management is how you will put that capital to work regarding trade management and share size.
Good trading creates income; good trading with proper money management creates extraordinary income.
It can be very easy to blur the line between money management and risk management. Money management refers to the amount of money you will put at risk per trade, based on the total amount of equity in your account. The standard percentage of equity per trade is usually between 2%-3%. What does this mean?
Let’s say you have account equity of $10,000. A 2% risk per trade would equate to risking $200 per trade. That’s it no more, no less. The percentage you risk is going to be based on your tolerance for risk. If you like to take risk and are a young gun you can go as high as 5-10%.
If you are a nervous Nellie, you can go as low as 1%. The point is it must be a number you are comfortable with. Now, here is where most traders go astray about risk. If you remember anything about this lesson remember this: Risk is more than just a number. It must be a dollar amount you as a trader and business owner accept before you put on the trade.
Now, I know what you are thinking: “Of course I accept the risk.” But hold on and let’s think about some of your trades and how they played themselves out.
Have you made any trades recently where a position reached your stop loss point but you did not get out of the trade?
Did you ever sit down and ask yourself why you didn’t get out where you said you would? Here is the key: most traders assume putting on a trade is accepting risk. Well, I have news for you, it’s not. To truly accept the risk of a position you enter, you have to accept two things:
- The dollar amount you are risking can be lost
- The fact that there is a possibility the position will move against you.
I know this sounds like stuff you know already but think about it: if you truly accepting the possibility of losing the money before the trade and you were OK with it, why would you not get out? I’ll tell you why. You didn’t prepare for the position to move against you, you were only ready to book a profit. So when the time came to do something about an unprofitable trade, you were caught off guard. Next time you place a trade, “accept” the risk before the trade.
A word about stop losses. To many traders the stop loss is an evil word. It represents a situation that is telling them, you have to face a trade that is not working out. To many traders this is the equivalent of scratching nails on a chalkboard. Try this mental tip the next time you need to execute a stop loss. “I am getting back to cash and will play for a better position.” No stress, no assault to your ego or brilliant analysis.
This article is a sample of the education from our new training program the DNA of Successful Trading, which will launch on September 16, 2013.
That’s all for today, have a great day!
SMB U
