By Gabe Velazquez, Online Trading Academy E-minis Instructor*
Posted: Jan 29, 2010
Very early on, on the first day of any class I teach, I write on the white board these two words in big bold print: EMBRACE RISK. It would seem that everyone looking to get involved in trading, whether on a full-time or part-time basis, understands that trading is a risky business, so embracing risk would be a given. When asked, most of the students will acknowledge that they are indeed willing to assume some degree of risk – some more than others – and that's typical.
However, when we begin discussing technical analysis and trading set-ups, those same students who assured me that they didn't have a problem taking losses begin asking questions such as, "How do I know if it will hold that support or resistance level?" or "What if it doesn't hold?".
Another one of my favorites is "What do you use for confirmation?" to which I reply, "I put on the trade, and let it work or fail. Confirmation is the trade working.” This answer always seems to elicit a puzzled look.
Now, this last statement flies in the face of what many traders have been conditioned to look for. Many new traders seek out multiple technical indicators, in essence, searching for multiple layers of assurances for their trades. The problem I see with this that, by the time all the stars line up (so to speak), these traders are usually entering the trade too late, thereby increasing their risk of missing the trade entirely.
This inability to pull the trigger when an opportunity presents itself is a direct result of the self-doubt generated when one does not TRULY ACCEPT THE RISK on the trade (I'll expound on this later).
What I also find interesting is that, when we start the first trading segment of the class, I begin to hear the sighs of vexation every time a student has a stop triggered (takes a loss). It's as though this student just received a body blow. Some students even begin to take every loss personally. With others, I have to suggest that they step back and take a deep breath before they continue their trading because they've become overwrought and are no longer thinking logically.
It's at this juncture when students really find out how they react to losses emotionally. Changing their attitudes about losing and being right is truly where the work begins.
Let's delve into this notion of unconditionally accepting losses as part of trading, which in my humble opinion is one of the biggest obstacles for most traders to overcome. It goes without saying that we never put on a trade expecting to lose, and most traders do place a stop loss just in case the trade doesn't work.
Yet, when price approaches the stop level, the natural tendency for the non-professional trader is to move the stop away from the market in hopes that the market will recover. The next adjustment in his or her avoidance of losing is to pull the stop altogether, or worse, double-down on the position.
Moreover, when a trade initially goes against the non-professional, and then recovers to a break-even level, this trader will close out the trade, relieved that he or she didn't lose money. Invariably though, as soon as this trader exits at break-even, the trade goes on to do exactly as analysis had suggested – causing the trader to be immensely irritated.
Regrettably, this begins a vicious cycle that can only be broken by gaining confidence in a methodology and coming to terms with risk acceptance. So you see: Placing a hard stop does not necessarily endow a trader with the "risk taker" attribute.
In class, I encourage students to think in terms of risk versus reward, as well as probabilities. I won't go into risk / reward now, but, rather, I will discuss the odds game.
Much like a professional poker player, a trader must find an edge. A poker player works at memorizing what card pairings offer the highest chances for him or her to win. The poker player understands that, aside from the initial ante, he or she only presses a bet when the odds are in his or her favor.
What's more, those who play poker professionally understand that they may not win for a series of hands, but, if they play enough hands, their edge will win out over time. Similarly, the professional trader will put on his or her trades in a systematic fashion without fear of losing or being wrong. He or she sees every trade as only one in a series of hundreds or possibly thousands in a trading career.
I understand this is much easier said than done, and it will probably take some work to modify your thinking. On the other hand, those traders who can't get over their fear of losing or being wrong will always operate in an environment full of stress and anxiety. Sure, they'll have their ups and downs, but at some point, trading will become drudgery and not much fun.
Then again, for those of you who truly want to take your trading to the next level and experience the satisfaction of seeing a rising equity curve over months and years, next time you spot an opportunity, predefine your risk, put on the trade without hesitation or doubt and let the chips fall where they may.
After all, what's the worst that can happen? You might lose a few bucks, or perhaps the trade works and you attain your profit target. If your profits exceed your losses by a margin of better than three-to-one and you have an edge (higher than 50 / 50 probability), your chances of being consistently profitable will vastly improve. That is, provided you accept the outcome on every trade. In other words, you must truly embrace risk in order to become a professional trader.
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