Defining your risk

"Never test the depth of the river with both feet" - Warren Buffet

No matter which trading books you read or professional traders you follow via websites and social media, they all scream one thing “Discipline is Key”. On the surface, in the videos you watch, trading looks so simple and the people doing it look and sound so relaxed and in control.

The reason for this is that first of all they have a wealth of experience. Secondly, and most importantly, they have a trading plan which they execute flawlessly every single time they trade. They use the information at their disposal to form an opinion on what is likely to happen next. They know and accept that the trade might go against them, so before they enter their money into the market they will have pre-defined a point at which they will exit the market no matter what. They accept that they will not win every trade they make. They will also never chase after a loss. This is what sets the professionals and the amateurs apart. They also analyse the information as it comes along, they might have entered a trade, initially it was going their way, then suddenly it starts to backtrack and looks like it’s about to go against them. They have no hesitation in exiting the position even if it means they only break-even. They have evolved their mind over time and removed that inner desire of the need to be right every time they enter the markets.

When it comes to creating your own trading strategy, minimizing risk, accepting losses and defining your exit point should form a big part of your plan. Understand the potential risks involved, how you will deal with them, and then train your mind and body to close out a losing position until hitting that button becomes your first instinct should the market reach your pre-defined exit point.

Once you have done your research, you will see that the big players never put their entire bankroll at risk on a single trade. Why give yourself only 1 chance of being right? Why not give yourself as many chances as possible? As an example, if you had a bankroll of £1000, would you rather have 1 chance using £1000, 20 chances using £50, or even 50 chances using £20? If you answered 1 chance using £1000, then you are pretty much gambling rather than trading.

You are also gambling if/when a trade goes against you, into the red, towards, on or even past your exit point, hoping that it will bounce back in your favour. Worse still, you take it in-play hoping that it will come back into the green. Subsequently it doesn’t, and depending on which way you entered first, you either lose your entire stake, or you become accountable for the pay-out at substantially higher odds because you layed first. We have all been there, even the most experienced of traders, most likely in their earlier days. It is a very expensive lesson to learn.

Entering the market, you have 2 options; you can back first, expecting the odds to go down; or, you can lay first, expecting the odds to increase.

With backing first, the most you can ever lose is your entire stake. Laying first, you become accountable for the pay-out should your selection go on to win. Generally you stand to lose a lot more by laying first. There is an exception to this; when the odds are 2.0 (even money) or lower. You will hear a lot of the pro’s saying “the upside is much bigger than the downside”. This applies to short-odds favourites under 2.0, generally quite a bit below 2.0, such as around 1.25 where their potential liability is only one quarter of their stake. Again, the pro’s, no matter which side they enter on first will have a pre-determined amount of money or a number of ticks they are prepared to lose, at which point they will exit the trade should it reach that point. They would never let it get to the stage where they have lost their entire initial stake amount, nor be fully accountable for the maximum potential pay-out.

We would hope that when developing your trading plan, you spend the bulk of your time defining your exit strategy.

 

 

 

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