Many championship sports team became champions by building the best defenses in their league. Why focus on defense? Why not focus on scoring points and offense? In sports I believe it is much easier to avoid your opponent from scoring in the first place than to have to play catch up. If a defense keeps the other team from scoring many points then their offense can stay on track and keep their high probability scoring plan in place. If a team starts getting behind they have to try more and more risky plays for a chance to win. They have little choice but to start running low probability plays to score quickly because time is the enemy of a team down a lot of points becasue the game will end before they can catch up. In American football it is much easier to win if your opponent is kept to 3 point field goals and all you have to do is score a few touchdowns. It does no good to have the best offense that can score 49 points in a game if your defense gives up 50 points.
The same principles apply to trading. If you never have any big losses then all you need is a few big wins to be profitable. If you never have a draw down of 20% then you never have to fight your way out of that hole with a 25% gain to get back to even. If you keep your losses to 1% of total trading capital then you only need returns of 3% of total trading capital for great annual returns. Risk management is defense for traders. If you are a master of managing your downside risk your upside profits will be much easier. Any robust trading method can be turned into a losing one by trading too big of a position size and opening up the trader to huge losses when a string of losing trades eventually happens. It doesn’t matter how much money you make in the markets if you eventually give it all back.
“Where you want to be is always in control, never wishing, always trading, and always first and foremost protecting your ass. That’s why most people lose money as individual investors or traders because they’re not focusing on losing money. They need to focus on the money that they have at risk and how much capital is at risk in any single investment they have. If everyone spent 90 percent of their time on that, not 90 percent of the time on pie-in-the-sky ideas on how much money they’re going to make. Then they will be incredibly successful investors.” -Paul Tudor Jones
