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Risk Vs Reward

Risk is a part of trading. Every trade carries a certain level of risk. Every trader must know the amount of risk that is being assumed on each trade. Knowing the amount of risk on each trade is one way to limit it and to protect your trading account. The best way to know your risk is to determine the risk-reward ratio. It is one of the most effective risk management tools used in trading.

The risk-reward ratio is a parameter that helps a trader to determine the level of risk in a trade. It shows how much a trader is risking versus the potential reward (or profit) on a trade. While this may seem simplistic, many traders neglect taking this step and often find that their losses are very large.

The minimum risk vs reward ratio for a good forex system should be 1:2, however a larger ratio is always better.

How to determine the risk vs reward ratio?

<!–[if !supportLists]–>1.       <!–[endif]–>Determine the amount of risk for the trade. This is equal to your entry price minus your stop loss price or potential exit price.

<!–[if !supportLists]–>2.       <!–[endif]–>Determine the potential reward on the trade. Based on your analysis or system, the potential exit price minus your entry price is your reward.

When Things Go Wrong

The trade falls apart. The stop loss gets hit, but your dealer doesn’t get you out of the trade. Or the spreads widen. Or you forget you have an order in the system and it triggers, and you’re on vacation, and you’re just having a great time until you are on the White Knuckler roller coaster ride and you think to yourself:

Trading is much like holding a fire in your hand.

At the same time, it’s beautiful and mesmerizing (for some of you at least). It hurts, too. When you have a bad trade, you are holding fire in your hands, so to speak. What are you going to do with it? Take a picture of it? Hide from it? Close your hand on it? Blow on it? Pour gasoline on top of it?

We don’t always react in the best of ways to the unexpected trade. Especially if the trade is a loser, or a mistake, we are likely to try to hide from it first. We flee from the scene of the crime.

If things don’t go your way in trading, tackle the situation. Get on top of it. Figure something out, and do it with friends, and do it sooner rather than later. You’ll be happy you put out the fire in your hand.

Resolutions For 2012

Resolutions On Trading & Investing:

  • Define my trading plan and stay with it.
  • Take no trades without establishing a complete and precise trading plan before the initial trigger.
  • Keep an open mind for new market scenarios based on what the price action and pattern setups provide.
  • Always trade with the trend.
  • The less trading I do, the better my results so for 2012 I’m adoping weekly/monthly time frames
  • Once I am in a trade, stick with the original plan for target and stop-loss – Don’t panic!
  • Make every trade meet the strategy requirements and what happens from there is up to the market.
  • I need to exercise greater patience in both buying and selling.
  • Be more willing to take a position, even if it is very small. It is tough though to gain the confidence to do so as the market has been tough.
  • I am NOT going to overtrade. I will only make “A” trades.
  • Don’t ever force a trade, stay in cash when unsure.
  • I resolve not to violate my stops.
  • Wait for opportunities instead of looking for trades.
  • Do not make a move until your indicators say so.
  • Follow this important Gartman rule: “Do more of what is working and less of what is not.”
  • To clarify my trading approach in my mind and in writing.
  • Be dispassionate and thoroughly objective when evaluating positions.
  • Do not be afraid to cut a loss, even if the trade is later re-entered at a higher price / better set-up
  • Never trade on impulse.
  • To memorize and practice the cardinal rules of trading.
  • Only trade when you can pay very close attention or exclusive attention to the market.
  • Dedicate more time during non-market hours to prepare for trading.
  • Take emotion out of my trading. Follow price action.
  • I need to overcome my unreasonable fear of the market.
  • Try to avoid personal bias in making decisions.
  • Wait for pattern to work out – do not jump the gun.
  • Don’t be in such a damn hurry. Wait out the times when the setup is just not there.
  • Avoid buy and hold in times of high market volatility.
  • Actually ignore the news and trade the charts! It’s harder than it sounds.
  • Don’t force the trade. The market will open again tomorrow and there will be new opportunities.
  • Don’t turn a trade into an investment. Continue to focus on price action.
  • Approach each trading day well-rested, of clear mind, and with a positive, opportunistic attitude just like Kirk

 
Resolutions On Learning:

  • Learn to do 1-2 things very well and focus.
  • Write the plan for the year ahead. Specify initial position, goals, entrance and exit strategies for action, identify risks to take and manage.
  • Study more on the weekends to prepare for the upcoming week.
  • I will be more diligent in keeping a journal of EVERY trade made in the year.
  • Quit searching for the holy grail of trading – there is none.
  • Turn off CNBC and all other distractions in the way of my success
  • I will keep good records and document all of my research, trades, and outcomes.
  • Use the right side of my brain and be careful of the left.
  • Do not blindly follow anyone else.
  • Accept failure and move on.
  • Methodically analyze what went right and wrong on each trade.
  • Spend more time nightly looking at charts.
  • Learn 10 new chart patterns this year and trade only setups identified by those patterns.
  • Apply a consistent decision tree toward every single trade.
  • Tune out the noise. No calls during the day. No more “experts”, no more TV and definitely, absolutely and without a smidge of doubt no more twitter.
  • Transition from paper trading to live trading.
  • Need to read more charts and read less newspapers.
  • Assess my strengths and what is working well for me and determine how I can improve. Also, assess what does not add value and eliminate it.
  • Stay with low risk, probability based methods.
  • Every trade I take requires a one page description of why, how, and at what levels I intend to take action.
  • Paper trade new ideas before putting real money at risk.
  • Study and read more, establish a trading plan, follow the plan, experiment, re-evaluate and keep learning.
  • I resolve to improve myself by: managing my emotions better, become more patient and understanding, define my goals more completely, and constantly review my efforts to these accords.
  • My resolution would be to trade/invest during all market conditions. Emotion still has some control over my investments.
  • Work on consistency!! (more…)

Market Truisms and Axioms

Commandment #1: “Thou Shall Not Trade Against the Trend.”

• Portfolios heavy with underperforming stocks rarely outperform the stock market!

• There is nothing new on Wall Street. There can’t be because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again, mostly due to human nature.

• Sell when you can, not when you have to.

• Bulls make money, bears make money, and “pigs” get slaughtered.

• We can’t control the stock market. The very best we can do is to try to understand what the stock market is trying to tell us.

• Understanding mass psychology is just as important as understanding fundamentals and economics.

• Learn to take losses quickly, don’t expect to be right all the time, and learn from your mistakes.

• Don’t think you can consistently buy at the bottom or sell at the top. This can rarely be consistently done.

• When trading, remain objective. Don’t have a preconceived idea or prejudice. Said another way, “the great names in Trading all have the same trait: An ability to shift on a dime when the shifting time comes.”

• Any dead fish can go with the flow. Yet, it takes a strong fish to swim against the flow. In other words, what seems “hard” at the time is usually, over time, right.

• Even the best looking chart can fall apart for no apparent reason. Thus, never fall in love with a position but instead remain vigilant in managing risk and expectations. Use volume as a confirming guidepost.

• When trading, if a stock doesn’t perform as expected within a short time period, either close it out or tighten your stop-loss point.

• As long as a stock is acting right and the market is “in-gear,” don’t be in a hurry to take a profit on the whole positions. Scale out instead.

• Never let a profitable trade turn into a loss, and never let an initial trading position turn into a long-term one because it is at a loss.

• Don’t buy a stock simply because it has had a big decline from its high and is now a “better value;” wait for the market to recognize “value” first. (more…)

Impulse Trades

Three things to know about Impulse trades for scalpers:

  • Impulse Trades are a strict No-No
  • If you do take it by mistake, don’t do it again if you want to be a serious profit-making trader
  • Ok, you did take an impulse trade ? Do the following:
    Watch it more carefully than you would do with a normal trade that follows your system.
    Keep a stop loss or limit in mind immediately and no matter what, GET OUT at that level. If it moves in your direction, trail it with the same rigourous discipline.

What makes a trader consistently profitable?

There are three things:
 
1) Having an edge, which is some methodology for determining with reasonable accuracy the relative probability of the market price hitting your profit target before it hits your stop loss price.  An edge is provided by a set of trading strategies, and a set of rules for when to use which trading strategies (briefly, when to follow a trend, when to fade a trend, and when to stay out.)
 
2) The discipline and emotional fortitude to follow the rules of your trading rules flawlessly.
 
3) Sound risk and money management rules.  
 
Sound money management and risk control are the keys to being a profitable trader. It is not the prediction or the latest and greatest indicator that makes the profit in trading, it is how you apply sound trading discipline with superior cash management and risk control that makes the difference between success and failure.  (more…)

Managing the fear of making a loss

Managing lossBefore entering a trade I know what type of loss I am happy to accept and I set my stop loss at about that level. Making a loss is part of trading. So long as the losses are small and the wins are large, life is great. Sometimes I have taken several losses in a row, which makes placing that next trade a bit harder because I think about the prior loss. I have overcome this by telling myself that the next trade “is just one of many thousands of trades that I will do in the future” and then I look forward to the next entry.

Cut your losses quickly, let your winning trades run, and allow trades to take their course. Be happy to make small losses, since the next trade may be the big one. Congratulate yourself when you have stuck to your plan, even if you have made a loss.

Stoploss

 

I’m sure everyone has been presented with the following logic: put in a ‘stop-loss’ at some arbitrary amount, say losing 1%. Then, your payoff distribution is tilted towards infinity, as shown above. It’s like the idea of going to Vegas, and saying you will stop when you lose $500, so you think that you still have an equal chance of generating those +$500 and up numbers, and the bad outcomes are just truncated at -$500. Alas, it doesn’t work like the graphs above. Instead, it generates the graph below, with a lot of probability mass at the stop-loss point:

 

Why traders wins & loses

WIN-LOSE

Why traders wins

1. Develop specific procedures.
2. Have a defined operational methodology.
3. Understand how your trading system works.
4. Be sufficiently capitalized.
5. Don’t take quick profits.
6. Begin using a system after it draws down.
7. Be willing to accept consecutive losses.
8. Don’t think too much.
9. Don’t set specific price target.
10. Don’t believe the tight stop loss myth.
11. Play your own game-avoid the news.

Why traders loses

1. Lack of defined methodology.
2. Poor self control and discipline.
3. Information overload.
4. Riding losses.
5. Taking profit quickly.
6. Poor understanding of system basics.
7. Lack of consistency.
8. Too emotional and suggestible.
9. Too close the makes.
10. Can’t accept more than a few consecutive losses.

Lessons from the Wizards

All successful traders use methods that suit their personality; You are neither Waren Buffett nor George Soros nor Jesse Livermore; Don’t assume you can trade like them.

What the market does is beyond your control; Your reaction to the market, however, is not beyond your control. Indeed, its the ONLY thing you can control.

To be a winner, you have to be willing to take a loss; (The Stop-Loss Breakdown)

HOPE is not a word in the winning Trader’s vocabulary;

When you are on a losing streak — and you will eventually find yourself on one — reduce your position size;

Don’t underestimate the time it takes to succeed as a trader — it takes 10 years to become very good at anything; (There Are No Shortcuts)

Trading is a vocation — not a hobby

Have a business/trading plan

Identify your greatest weakness, Be honest — and DEAL with it

There are times when the best thing to do is nothing; Learn to recognize these times
(Nothing Doing)

Being a great trader is a process. It’s a race with no finish line.

Other people’s opinions are meaningless to you; Make your own trading decisions
(The Wrong Crowd)

Analyze your past trades. Study what happened to the stocks after you closed the position. Consider your P&L game tapes and go over them the way Vince Lombardi Bill Parcells reviewed past Superbowls

Excessive leverage can knock you out of the game permanently

The Best traders continue to learn — and adapt to changing conditions

Don’t just stand there and let the truck roll over you

Being wrong is acceptable — staying wrong is unforgivable

Contain your losses (Protect Your Backside)

Good traders manage the downside; They don’t worry about the upside

Wall street research reports are biased

Knowing when to get out of a position is as important as when to get in

To excel, you have to put in hard work

Discipline, Discipline, Discipline !