Sunday, December 21, 2014

How a trader's approach to risk can change

"There are old traders and there are bold traders, but there are very few old, bold traders." - Ed Seykota

When the vast majority of people start trading, getting the perfect entries and exits dominate their thoughts. Little or no regard is given to risk. All they are concerned about is the potential rewards -  how much money they can make, and the sooner, the better.

If they somehow manage to survive this initial period, they will start becoming accustomed to risk control dominating their thoughts. At this point, they may occasionally resist, but with some larger than acceptable losses (either by risking too much, by overriding an exit signal, or by taking on too many trades at one time), they start to learn - the hard way. The realisation dawns on them that, if they don't improve their risk control, they won't be in the game for much longer.

Before long, they start to embrace risk. They now believe and take comfort that good risk control is their safety mechanism. With good risk control, they have greatly reduced their chances of suffering a devastating drawdown or an equity blow up. This helps them develop discipline in their approach, and gives them confidence that, just maybe, they can trade profitably over the long-term.

Trading through a price shock, such as an earnings gap against them, or other unexpected event and emerging relatively unscathed, as a direct result of using good risk control, further reinforces their belief.

Finally, their whole approach to trading revolves around risk and how they control it at all times. They measure any gains or losses in terms of risk and rewards, and the relationship between the two. This, along with their win rate allows them to start quantifying their approach by way of calculating their expectancy.

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