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amount of financial risk required to enter into the trade. When you determine your stop loss point and the potential for profit, your rules must be consistent. Your goal is to be able to quantify your strategy and adjust it accordingly. This is possible only when you can define how much you will risk to earn the possible potential profit. Your potential for profit will also require you to have a clearly defined exit strategy. |
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An analogy sums it up best. If you view the trading environment as a never-ending battle, and your trade as a soldier entering the battlefield, then your "soldier" needs to be conscious of where to run for cover. Similarly where you put your stop is where your trader soldier runs for cover. In other words, prior to putting on a trade, you need to consider a number of things concerning risk profile. These are: |
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2. The possible correlations in your portfolio and the impact of a particular trade on your portfolio risk. |
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3. The amount of risk inherent in the tradehow far away is the sandbag? |
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4. The amount of money you want to put into action. |
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5. Whether the trade is repeatable and can contribute to your methodology probability. (In other words, are you no longer flipping coins, but working with probabilities?) Remember, if a trade isn't repeatable, it probably isn't "retradable" and therefore requires a total dollar risk assessment. If you want to trade the end of the world, make sure it counts. Make sure that if the world doesn't end you still have money and recognize the trade for what it isa one-time solitary event never likely to repeat, meaning that your probabilities don't exist, which bring in the final criterion. |
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Every outstanding trader has very strict rules on how to manage risk. Without a very clear strategy, your ultimate success is greatly diminished; with it, your success is almost assured! |
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