Being in the financial markets and operating with many volatilities, that is, with constantly changing prices, requires we have an extremely good risk management if we want to remain in the markets.
I believe that out of the four rules that one should follow to become an excellent trader, this is the most important of all.
When it comes to risk management, you must be aware of how far you are willing to risk in a trade. Depending on an expectation, an input signal that the graphics provide, depending on each of the issues that make trading. If one is not clear about how they want to manage the risk that this operation brings, that entry into the market has a problem.
And that problem will indicate a subsequent loss of money and consequently loss of capital. If this is repetitive and constant in each operation, it will cause the operator’s account to move towards total destruction. This, of course, would happen if they fail to establish a pattern with which he can consciously manage the risk of what he is doing in the market.
One of the issues that I ponder the most, is to determine how much I am willing to lose in this operation before entering a trade. In the examples that I give later, you will see that in all cases I made them numerical so that the concept of how much I’m willing to risk is properly understood.
One of the rules that I’ve learned over the years is that before opening the entrance to an operation, it is necessary to be clear where the output or profit objective of this execution is and where the loss stop will be if the trade goes against my initial intention.
Without this well established before entering the market, the result would be an operation without discipline. Therefore, away from the methodology and with risk to a loss greater than originally expected.
The training I have on the markets I acquired with experience. That is in the beginning, I researched on the web and traded with demo accounts that allowed me to simulate and perform operations without real money. This aided me in understanding how to enter and exit the market and where to place my limits.
Both Forex and Futures markets are markets that I experienced and that I do not advise operating with at the beginning. Since they are very volatile and leveraged, that makes losing or earning money a quick operation. For this management, one must be prepared, because as in other markets there is always a demand of assuming responsibilities on the part of the trader; but Forex, above all, surprises by their movements, which are extremely fast and violent.
As I mentioned before, my training in operating financial markets was developed slowly over many years. I started shortly before 2001, first with actions without a distinct idea of when to enter and exit and with very limited risk management. Then I went on to Forex and Futures and little by little I got to meet experienced and effective professionals in the business.
A rule regarding risk management that I always apply and that I assimilated over the years, is to limit the loss to a maximum of 2%. This means that if I have a loss for several operations followed up to 6% (that is, three operations in the course of a prudential lapse that can be a month or less, depending on when the loss occurs) I stop and analyze why my account fell 6% and what I am doing wrong.
In these situations, it is advisable to reduce the size of our trading to manage what is being done. In addition, at startup, it is convenient to carry out operations that seek to limit the loss to something less – like 0.5%.
In my current methodology, I try entering operations with a possible loss level similar to 1% and attempt to manage it so that the exit of that trade is with 2% in the week. If I perform this successfully, I get an 8% of the capital in one month and for me, that is more than enough.
It is significant to measure how much is enough since humans are ambitious by nature and if a level is not placed at the exit, it can be counterproductive. At least that has been my experience. My market entries are always resolved in a matter of hours or in some circumstances, days, but they almost never exceed a week until I close.
The typical way in which I operate in general is to set the stop loss at 1%. As the trade develops in favor of what I am executing, I move the stop loss, in the first instance if the market allows it to the entry value, thus not losing money in that operation.
That way, when I continue growing my operation, I run the stop loss again up to 2%. At the end of the week, I go out to on the maximum possible value above 2%, depending on what the Bollinger Bands indicate, the cut of the MA21 or the proximity to the weekend. In my case, I prefer being liquid again to sleep peacefully and enjoy the weekend with my family; the following week everything starts anew. This is how I treat trading on a weekly basis.
Take as an example the share of APPL (Apple). Here, the entry price that the method points to is 142.50 USD and the stop loss is set at 140.50 USD. That being said, this shows that I will have a distance of 2 USD between the stop loss and my entry if I only intend risking 0.5% of my account. This is 50 USD, so, 50/2 = 25, which represents the number of shares I can buy without risking more than 0.5%. With the distance to the stop loss defined and to determine the winning distance, this will be the one that allows me to earn 2% of my account since that is my weekly goal. Therefore, I will look for the distance of 200 USD which is 2% of my account. This is calculated as 200/25 = 8 so that AAPL should reach 150.50 USD so that I can exit the operation with a 2% profit on my account.
In this way, I decide the point of entry, also the stop loss with a loss no greater than 0.5% and the exit point with a goal of 2%. As we can see, before entering the operation we are clear about all the AAPL prices that will allow me to accomplish my objective in the example. They would be 142.50 the entrance, 140.50 the stop loss and 150.50 the exit point.