Monday, October 22, 2012

Overtrading

Any method of trading suffers periods of drawdown, and a string of losses can have a devastating impact upon your equity. Making sure that you have your risk parameters set at sensible levels is a pre-requisite for long-term trading success. Even if you are using a system with a high positive expectancy, you always need to ensure that you factor in the unexpected when determining risk levels.

To quote from his Market Wizards interview, famed trader Bruce Kovner said the following:

"...I would say that risk management is the most important thing to be well understood. Undertrade, undertrade, undertrade is my second piece of advice. Whatever you think your position ought to be, cut it at least in half. My experience with novice traders is that they trade three to five times too big. They are taking 5 to 10 percent risks on a trade when they should be taking 1 to 2 percent risks."

This is obviously difficult to implement properly when new traders are starting off with very small trading accounts. At that point in time, luck can play a factor in whether you are able to grow your initial trading stake, as not only the overall success of your trades, but also the order in which they occur, can make or break the account. However, you should seek to employ rigid, conservative risk parameters as soon as possible. Not only does this give you discipline, it also eliminates the possibility of an inexperienced trader blowing up their account after having some initial success with their early trades.

Overtrading also manifests itself with greed - after a run of profitable trades, or a good week or month, traders can be tempted to ramp up their position size, thinking that they can make money faster. By the same token, you are also opening yourself up to losing money a lot faster as well. So, next time you think about doing this, think again. Trading is a marathon, not a sprint, and the No. 1 rule is to ensure that you stay in the game.

No comments:

Post a Comment