Posts Tagged ‘trading risk management’
Minimize Your Trading Losses And Master The Markets
As traders, one of our most important responsibilities is to define both our trading float as well as our trade loss limits. Of course, our trade loss is essentially the maximum amount of money we’re willing to loose as a result of any one trade we make. By defining these parameters we not only ensure losses are kept at a bare minimum, but we all protect ourselves against the effects of multiple losses occurring one after the other.
If traders in general were more reluctant to risk too much, there would be far less failures in the game. Yes, one does have to keep enough a large position open for turning a profit but at the same time, one also has to ensure losses are minimal.
You’ve more than likely heard of Steve Waugh, a former cricket captain for the Australian team? Well, he once stated that protecting your wickets and staying in the game was of far greater importance than simply making runs. In trading, your trading float is your wickets and if you loose it, you’re out of the game.
Always being aware of the maximum loss I’m willing to accept, doesn’t mean I’m negative. Instead, because I employ a meaningful trading psychology, I’ve learnt to be on the defensive at all times. After all, it’s all about survival.
Ed Seykota, a top trader, once gave his version of defining the three elements of modern trading:
1) Cutting your losses
2) Cutting your losses
3) Cutting your losses
He was also quoted as saying, “Follow these rules and you may just have a chance.
Losses are a part of trading and they’re something all traders experience. Having said this, professional traders have learnt how to deal with losses. They know they need to accept their losses and then carry on. Under no circumstances do they ever allow losses to cloud the judgment because they realize that if they did, the results could be devastating.
What is the ideal maximum trade loss? According to many studies, the ideal figure seems to be 2% of your trade float, hence the well known 2% trading rule. Of course there are also scores of professionals who refuse to risk more than 1% of their float on any one trade. Remember though, while this certainly minimizes the effect of any losses, it also means your profits won’t be very big.
If for example we applied the 2% rule while trading with a ,000 float, the biggest loss possible from any one trade would be 0. Because the maximum loss is kept so small, it would take numerous losses, all occurring in a row, before our entire float is lost.
To drive the point home even further, with a maximum trade loss of 0, you would need to experience a string of 50 losses before your float would be depleted. However, because the 2% rule is applied to your current float amount and not to the initial float amount, you would actually need even more than fifty losses. Even by the wildest stretch of imagination, experiencing so many consecutive losses is virtually impossible.
Let’s take a look at how this works:
Starting with a K float we have our first loss based on the 2% rule. As we know, this would me we loose 0 which in turn leaves us with ,600. Once again, we apply the 2% rule on our next trade, thus meaning the maximum loss we expect would be 2. Now let’s see what happens when life treats us really bad and we experience a string of six losses:
Float amount: $20,000
Float after 1st loss: $19,600
Float after 2nd loss: $19,208
Float after 3rd loss: $18,824
Float after 4th loss: $18,447
Float after 5th loss: $18,079
Float after 6th loss: $17,717
Even after six consecutive losses, we’re still left with ,717 in our float. If you ask me, this is what I call, “trading risk management“