Find Your Risk Comfort Zone
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Are you trading within your means? In today's volatile markets, the price range of a single day's trading can be quite large. If you are trading wisely, you are defining your risk exposure before you place your trade, and usually this is done by using a stop-loss. But where are you placing your stop-loss? What are you using to define your risk exposure? At the very least, you may be using the range of previous day's price action as your allotted risk. For example, if you are entering the market LONG (buying) when price moves above the high of the previous day, perhaps your stop-loss is placed just below the low of the previous day, or current day if lower. The logic behind this is that if you are going LONG (buying), you expect current lows to hold and are hoping for higher-highs to be made instead. Unfortunately, some accounts are not large enough to handle the risk exposure some markets would present when using a complete day's trading range. How much might one consider risking on any given trade? Well, to answer this question requires several variables, including the win/loss ratio of the methods used, the gain/loss per trade averages, and what you can psychologically handle. This is clearly going to be different for each trader. W. D. Gann advocated risking no more than 10% of the account on any given trade. Well, that may work well for someone of W. D. Gann's caliber, but it may not be for you. For ANY person, however, the amount should NEVER be more than 10% and more likely should be LESS. Simple math will help you determine whether your wins vs. losses and the average profit and average loss numbers will put you ahead if you divide your account by 10 or 20 equal size chunks to risk. But math will NOT have any bearing on the psychological variable that should be addressed. Suppose that trading one contract of a certain market, say Soybeans, would require that you risk 10% or so of your account. If the market moves against you, say 50-75% of the total risk amount, leaving you with just 25% from being stopped out, would you start to feel uneasy? Do you find thoughts starting to flood your mind about possibly getting out now rather than losing the whole 100% of the risk amount, or debating with yourself as to what to do next? The real measure of whether you are trading within your psychological comfort zone is if you look at the trade in negative territory, not yet at your stop-loss, and feel indifferent about it. If it gets stopped-out, not a problem. If it is not stopped-out, great. It does not matter how large or small your trading account is. What does matter is the amount you are risking in relation to the size of your account. Your account may statistically be large enough to handle the risk of one or more contracts. Yet, if you start feeling some discomfort or pain when the market does not immediately move in your favor, that is an indication that you need to SCALE DOWN your trade size to a more manageable level. What prevents some traders from doing this and therefore not only enduring unnecessary discomfort but unnecessary losses or lost opportunities for gain? GREED first...then FEAR! The GREED factor comes into play when a trader is so sure of the trade he/she is entering and wants to get the maximum profit in the shortest amount of time, that a position is put on that is really larger than should be put on. Thoughts of big profits cloud better judgement, and once the trade is on and moves in the direction the trader does not like, the mounting unrealized losses start to cause the trader to feel FEAR. At this point, judgement is clouded and the wrong decisions are most like going to be made at the wrong time. GREED is destructive to a trading account.
FEAR is destructive to a trading account and trader's psychology now and for future trades. What would you rather have: A. An account that slowly grows and grows, month-after-month. B. An account that quickly gets wiped out because lots of chances are being taken to make the big killing in trades. At the end of the trip, I'm sure you would want to be in the green and playing on the green, rather than in the red and your account is dead. Okay, so you have decided that you are going to control your GREED and FEAR by trading more manageable lots. But what if the trade setups seem to produce too much risk for even just one contract for the size of account you have? Today, there are several markets that you can trade MINI lots. Currencies, grains, metals, indexes and others have MINI-sized contracts. Of course some are less liquid than others and may be much less than the full-size contract. However, there is enough liquidity in many of these to make it worth looking into. Now, if your mind is immediately thinking that you will not get as big a bang per tick using a MINI as the regular size contracts and that starts to bother you, you are already falling back to the original problem of GREED. Of course a single contract in Soybeans might move 15, 20 or 30 cents in a day (at $50 per one-cent move) that equates to anywhere from $750, $1000 and $1500 per contract (respectively) in a single day. But keep in mind that if the market moves against you, that amount is what you have to endure as a potential loss. But if you were to trade the Soybeans MINI contract, which is one-fifth the size at just $10 per one-cent move, then you're looking at daily moves of $150, $200 and $300 per day. If you cannot feel calm about a move against your account of just $300, then your trading account is seriously too small for trading and you should consider adding additional funds before you do any trades. The point is that you must find YOUR comfort level. You must discover how much draw down you can have that does not make you concerned at all. If you start to feel a little tinge at some loss amount in respects to your account size, note the percentage of your account that the loss represents and LOWER it by at least 1 percent as your comfort ratio. Then DO NOT exceed that ratio at any time for all future trades. FREE Trading System!