As the saying goes...
As the saying goes, If you don’t manage risk you won’t have risk to manage.”
A simple way of saying that you could lose everything in your account if you leave it all at risk. Sophisticated short-term traders manage risk by always entering trades with at least a three-tiered plan.
The first element of any trade is our Entry.
Entry is the act of opening the trade. The trader’s goal should be to buy where big banks and institutions are buying. Let the buying power of big institutions drive the trade to profitability. If a trader is trading expecting the stock will drop, then the trader needs to enter a trade where they believe banks and institutions will sell and drive price down.
Understanding that not all our trades will work out, we must anticipate and minimize our risk. To ensure our losses are small and pre-defined, the trader needs to employ the second element of the trade…The Stop Order. The stop order is a predetermined price where the trader will exit the trade for a small loss. This is designed to get the trader out with a palatable loss. The stop loss is not fool proof during gaps or major market swings…but it does work effectively the majority of times it is used. The Stop Order is not negotiable. It keeps us safe and our losses manageable.
The third element of the trade is the Target.
The target is the predetermined price a trader will exit a trade for profit. The target is set based upon a rules-based system. The accurate setting of price targets is essential to consistency in the markets. It would thus stand to reason that the further a target is placed from our entry…the lower the probability price will reach the target becomes. Looking at a price target as a ratio, many successful traders look for trades that offer them at least a 2/1 reward to risk ratio.
For example: If the trader enters a trade with a potential dollar at risk the trader must believe that they have at least two dollars of profit or more to be obtained as a requirement for entry. We believe it is better to take less reward if it keeps us safe. Never be upset that you could have made more if you stayed in the trade….just make sure you never have to utter the words “How did I lose so much?”
Entry, Stop and Target are just the beginning of managing the risk of a trade or investment.
Much more needs to be discussed.
One more word of wisdom. Never put more money in a trade than you can afford to lose and still recover from using income from other areas of life. As your account grows you will change this risk principle to a percentage of banked profits.