The Pillars of Trading in Modern Markets – Part 2: Risk Management, August 19, 2014

Dear Traders,

Today I continue my mini-series of 5 articles with a new article. I will complete this series on Friday. Every day I publish a brief article. The focus of the series is on the “Pillars of Trading in Modern Markets”.

In Yesterday’s post I have written about the Trading Method.

20140811_advancedriskmanagementToday’s topic is a very crucial one- Risk Management. I will start by defining what Risk Management is, and the way I look at it.

Risk management, simply put, is the discipline and practice of protecting the trader’s capital. I have a rule in my trading – and its called PPC, Protect Precious Capital (rule #1). And this rule is rooted in a simple fact: “when the money is gone, the game is over”.

So what I mean, is to avoid coming to that point where you realize that your financial and emotional capitals are done and gone. To avoid this unfortunate outcome (that affect regularly a very large number of traders), you have to start taking control of the situation in an informed and practical way right from the start.

You have to do whatever it takes to protect your capital. And the first thing you have to do is to stop deceiving yourself that trading is easy and that next 100% “big trade” will happen soon enough and will cover up for your previous losses. I have lost money myself thinking like that and I regularly watch and talk to inexperienced traders who think that they can risk 10%, 20%, and sometimes even 100% (when they trade without stops) of their capital on one trade, only to discover that if they put pressure and expectations in their trading, they end up “imposing” their expectations to on Mr. Market.

But as we all know, markets can be highly unpredictable. Anything can happen, and this is a fundamental truth of trading. There is nothing we can impose on something that is totally free and wild like Mr. Market. We can have positive anticipations, but certainly no expectations.

When we deal with our capital we have to distinguish between financial capital and emotional capital, and keep them separate. Understanding of the former is quite straightforward: it’s the money you have in your trading account. But the latter is trickier. This is a measure of our confidence level in trading. If we lose confidence we become unable to act and make money. In fact, when act without confidence, it’s a sure-shot way of losing money.

Note: Confidence is always the combination of Knowledge + Proof. If we experience a streak of losses we lose the ‘Proof’ part of the equation. So we lose confidence even if we know very well how to trade a good system. In a status of no confidence, generated by a low emotional capital, we are not able to generate profits in the markets.

I have talked extensively about Risk Management in my last Webinar on which can be watched here:

Till then stay tuned. My topic for tomorrow will be Money Management.

Have a great day.

Giuseppe, ~FibStalker


Filed under Articles, Education, English language, Risk Management

4 responses to “The Pillars of Trading in Modern Markets – Part 2: Risk Management, August 19, 2014

  1. Hi Guiseppe, what you are saying in this article is exactly my problem. Next 100% “big trade” will happen soon enough and will cover up for your previous losses…

    Now I know that I had losses because of my pour sysem. Or because I closed my trades too soon with less profit than I should be having. Usually because I didnt know where to set my profit target and I exit at first visual support area.

    Now I realized that the system is the most important thing to have. And on the losing trades I risk more than I should.

    But the problem is mainly impatience to hold trades for longer period of time.

    And that killed my confidence and my emotional capital is almost gone.

    Very good article!

    • Hi Matt,
      I know how you feel because I have been there countless times, until I realized and was able to clearly understand the pattern. And then I stopped.
      That pattern becomes difficult to handle when we have expectations from trading and that need of “revenge” to come back from previous losses.
      The confidence coming from a method that works (knowledge of how to use it + proof that it works) can definitely help changing the pattern.
      The system is definitely important, but it is one of the components. Of course it has to make sense and be grounded in the way the market works.
      The best systems also take low-risk trades (hidden in retraces) and incorporate the psychology of the market.
      This allows to “naturally” go with the flow, i.e. trade in those spots were the majority is not willing to take a position, but professional traders and algos are loading the boat.

      Matt you need to bring your risk down to 1%. You now know that with the use of Market’s Money techniques you can build your wealth by getting aggressive on other people’s money.

      If you are not aware of that, watch the Webinar:

      Slow down, learn a good system and then restart slowly and keep adding capital as you go.

      Trading is an “evergreen” skill. There is no need to rush. Even if it takes months or years to learn it, it is going to be with you and serve well for ever.
      Takes time and efforts, and investments to learn it. But then will pay back for ever.

      Hope this helps.

  2. Khalida

    Great article. And the highlight is the correlation between Financial Capital and Emotional Capital- and keeping them separate. And this is the most difficult part. No matter how pragmatic our approach is for trading, we tend to sometimes go with our heart, or that little “feeling”.

    Thanks for your awesome tips and suggestions. Keep them coming 🙂

    • Hello Khalida,
      thanks for dropping a comment. You are right, we get into trading with our feets and whole body and probably not sometimes, but all the times, pushed by our emotions.
      Emotions cannot be eliminated, but can be mediated through understanding.
      Those involved in trading are not the emotions we generate with our hearts. Our hearts generate emotions of love and compassion.
      But the kind of emotions involved in trading are sort of “darker” 🙂 and more complex to manage.
      These are the emotions that come from our guts: fear and greed, mainly.
      Fear of losing financial capital (inexperienced traders we are not very much concerned with emotional capital, although it is as important as the financial capital) or fear of loosing opportunities, which pushes beginners to get excited and enter trades too late and with awful or nonexistent risk management.
      And then there is greed, the willing to increase one’s capital and financial account. That also brings around a lot of mistakes.
      When it comes to fear and greed I have a statement/rule and I make sure it always resounds in my mind. That is “if you see a price move and you are not in it, the price move has ended or it is close to an end”.
      Every time, in the past, I tried to get involved in those situations, more often than not price reversed on me.
      Hope it helps.
      Talk soon,

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