One of the key reasons I smoked the competition was risk management.
The psychology of trading is the most important for trading success. Risk management is number two.
Everybody knows that you should put a stop loss on all your trades. You need to control the risk on every trade. That is elementary.
But few people put a cap on the whole risk in the portfolio. I call this a Daily Risk Limit.
I think I first came upon this concept while trading for a major financial institution in New York. Basically, if you lost a certain amount in one day you were put in the “penalty box” for a day. The penalty box meant you were not allowed to trade for a period of time. If you lost too much in one day then you were in the penalty box for a day. If you lost a certain amount in one week then you were put in the penalty box for a week. And so on.
Being put in the penalty box was a big blow because that meant you couldn’t make money trading and therefore couldn’t make as big a bonus. Traders trade for the bonus not the salary. So you never wanted to be put in the penalty box!
I lived through the Crash of 1987. I saw many people get wiped out. Many. It was brutal. Businesses wiped out. Homes seized.
So I learned the lesson that you not only have to control the risk on one trade, you have to control the risk on your whole portfolio.
I started to use the concept of Daily Risk Limit after the Crash of 1987. The Daily Risk Limit is the amount of money you would lose in one day if every position you had was wiped out. That is the maximum amount of pain you would suffer in one day.
Presumably you would have no positions on at the end of the day.
I recommend you do this in your own trading. Set a Daily Risk Limit. How much would you be willing to lose if everything went to hell in a handbasket.
In the real world, this should maybe happen once in your lifetime. It assumes something huge is happening in the market and everything is correlated. Presumably you have something in your portfolio that will hopefully go in the opposite direction from your main positions.
I live and breathe this Daily Risk Limit.
It is part of what I do while I am putting together trades and a portfolio in our Stock Navigator Program. Yes, we have to focus on making money but we have to focus even more on not having large losses.
You can learn about the Stock Navigator program by clicking here.
There is the old saying that you CAN drown in a river with an average depth of only 6 inches. We never drown in the average depth of the river but in the maximum depth of the river. That is effectively the Daily Risk Limit.
You need to make sure that you can withstand the pain of that extraordinary day. You can learn more by clicking here.
Thanks!
Good macro trading,
Courtney
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