You better be managing risks on days like today, when the Dow Jones Industrial Average rockets up almost 500 points due to announcements from central banks. Shorts were punished once again, not by the normal market functions of supply and demand or emerging trends, but government interference. Such is life in the markets and trading.
You may think managing risk and position size is not needed because you will always be right, but in trading, literally anything can happen. Black Swan events are the new normal. You must use risk management to protect yourself through position sizing, stop losses, or trailing stops at ALL times. If you don’t, you will eventually blow up your account. A maximum of 1% of your trading capital should be at risk on any one trade, and no more than 3% of your capital should be exposed to losses in your total portfolio at one time. You will over shoot if you are on the wrong side of days like today, even at the opening bell. Agility is key: adjust quickly if that is the case, sell and start over.
Those who focus on making as much money as possible while ignoring risk will invariably lose the majority of their accounts. No matter how talented you are, you will face ruin, just as Jesse Livermore did and Victor Niederhoffer did on several occasions. Even the best traders like Alexander Elder and Nicolas Darvas blew up accounts when they first got started. Why? You simply can’t out trade the risk of ruin. If you risk a consistent 20% of your initial starting capital per trade you are done after just 5 losses. Everyone who has traded for any length of time has had five losses. If you risk 1% of your total starting capital per trade, 15 losses in a row will only bring you down 15%. Of course you can risk less in a drawdown or more with a proven robust system, but the key is risk management.
Seven Easy Steps to Blow Up your Trading Account
1. Don’t cut your loss, just hope it will come back.
2. Do not plan your entry and exit before you make a trade; make those decisions when your emotions are affecting you.
3. If you are unsure of what to do, just take a stab at it, go with your feelings.
4. Trade randomly with no defined edge.
5. Don’t track your trades. If a strategy loses money, just keep doing it.
6. Don’t focus on potential losses, but only on potential gains. Trade bigger and bigger as you lose money.
7. Don’t use a trailing stop, let a good profit disappear or turn into a loss because you want an even bigger profit.
Follow these steps and your account will be at zero in no time!
(Fortunately I had covered my shorts and went to cash on Monday, so I side stepped this Beartastrophe. You can follow me on twitter at SJosephBurns).