Risk Management Is the Key to Long-Term Trading Success

Risk management is what separates great traders from the masses.

Controlling risk, reducing risk, taking a planned loss with flawless execution, is what makes a trader great.

Learning to trade is easy. Learning to manage risk means you have control of your ego.

Overnight Risk Versus Profit Potential

risk managementWould you believe me if I said swing trading has more risk than day trading?

It’s true.

Risk management is relative to your style of trading. Pure day traders go home “flat.” No over-night risk. You, as a swing trader are exposed to any number of unforeseen catastrophes.

The profit potential is commensurate with the risk but, the key question is, how do you control the downside to justify the upside?

Most trading plans are focused on strategy. Sadly, plans for risk management are developed as an after-thought. This is why so many traders never turn profitable. Strategy is your map. Risk management means you are behind the wheel. Imagine driving with no sense of how to use the breaks?

When you treat your swing trading account like a real business you develop a mindset to address the risk. This means strategic planning that seeks to preserve capital while you test and discover your trading niche.

An eye doctor doesn’t fill cavities. You shouldn’t try to do everything in your trading account either.

Swing trading is first knowledge and then skill. The knowledge part is easy. To gain the skill- you need to place real trades and quickly reduce mistakes by ruthlessly paying attention to results.

The most common error made by swing traders is initiating positions out of line with either:

  • Their resources.
  • The probability of the trade.

Let’s discuss each so you can tame the beast that destroys most swing trading accounts.

Swing Trading Within Your Resources

Quick, make a list your trading resources…

Did you list any of your skills? Did you list risk management skills in particular?

You may think being well-capitalized is a blessing for a trader. It is and it isn’t.

It depends on your skill level and the the credibility of your edge. A well-funded account without experience or a trading strategy that works, is a funeral march to a separation of money and trader. Time-after-time I have witnessed talented traders buy large positions in a stock (or load up with options) simply because they could afford to. To put it simply this is dumb trading.

Too many traders consider it “money I can afford to lose.” Well guess what-you will lose it with that mindset.

Inevitably, if a trade goes south, they brag about the loss to show off they can afford it. The story gets deeper when they say “it’s not a loss until I sell.” Yeah right. Tell that to everyone in 2007-2008. How well did that plan work?

A large trading account is a luxury and should be focused on building rules, discipline and skills. You can afford to test ideas until you find the strategy that matches your personality. Your main resource is money but if you are sloppy the market will make you pay.

Embrace this valuable resources from the start so you can consider yourself a professional.

Professionals take their job seriously. Swing trading is a serious business.

High-probability Trading vs Reduced Commission Trading

Up until the late 1980’s it was too expensive for the average trader to be active. I remember clearly it was over $200 to initiate a new position.

You had to be very picky. The cost of the trade factored into trade frequency. As costs went down activity went up because the added expense for all intents and purposes was removed.

This isn’t necessarily a good thing. It’s too common today to place a trade because you have an account than because there is a really good reason to do so.

A common misconception about trading is that all trades should be treated equally. Same risk, same amount of shares etc. This is flat-out wrong. Some ideas are better!

I am going to define an inexperienced trader as anyone who does not earn consistent money on a quarterly basis. If you spend years trading but don’t earn money you have not learned anything. So with that context, inexperienced traders don’t understand there is a time to manage risk and there is a time to be aggressive.

Inexperienced traders see each trade nothing more than an opportunity to place an order. They don’t hold the good ones longer and take equal risk on the mediocre setups. It is critical you understand this distinction to become the best version of yourself as a trader.

This means you need to learn two things:

  • How to build a position.
  • How to assess conditions to distinguish the good from great opportunities to accept risk.

You always want to say “I lost money on a great idea. I would definitely take that trade again.”

Building a position implies you are managing risk until a position proves itself. You never load the boat until the idea is validated by price action. You build the position as price action moves in your favor. NEVER as it moves against you.

This way you have more shares when the position is a winner and less shares when price action fails.

Assessing conditions that imply a probability means you have clear and structured criteria that define the odds. This statement may seem to contradict the context of the article but the point is-the real risk in a trade is the quality of the idea. The better the odds the lower the risk.

Work hard to respect risk (no matter how big your account) and you should be well rewarded for it. Rick management makes trade management a whole lot easier.

 

 

About the Author

Pete is a full-time trader and mentor since 2000. Author of Equity Trader 101 and the Order Flow Method. He is dedicated to help self-directed traders to bust through the six-figure level.

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