When The Market Goes Awry, Get Back To Basics

Getting Back To The Basics Of Trading

The key to successful trading is consistency. You have to consistently execute your trading plan, taking care to follow strict entry rules, in order to gain an edge over the market. This edge should, hopefully, allow you to profit more often then you lose and to win bigger than you lose. Sometimes, times like these, even the most well-though plans can go awry and that is just a fact of trading.

When the market resets like this, when volatility is high and no asset is left unscathed, it pays to get back to the basics of trading. At the core of sound trading is money management and risk control, a factor I think contributed to the scale of the current market sell-off.

What is risk management, money management, and risk control? They are all roses of a different name, frameworks for how to treat a trading account, and the foundation of any successful trader’s arsenal of tools. To start, managing your trading account means preserving your capital. You can’t trade if you don’t have any money. The catch-22 is you can’t make any money if you don’t trade so you have to find a balance.

Most traders like to keep their trades small relative to the size of the account. A trade equal to 5% of the total account value may not sound like a lot but that size trade can whittle an account away quickly with only a few losses. For best results, trades equal to 1% to 3% of the account are best to ensure a long account life. Using a percent versus a set figure is useful for two reasons. The first is that your trade size will grow when your account grows so you make more profit with each win. The second is that the trade size shrinks with each loss so you lose less with each progressive loss.

Successful trader may choose to increase their trade size after a string of wins and that’s ok. A very successful trader may be comfortable with higher percentages like 5% for regular trading and that’s ok too. Successful traders also know that when volatility is up, and the markets are whipsawing like they are, it’s ok to reduce your trade size to reduce your risks.

Another tool for traders is the leverage. You may think of leverage as a gift from the brokers but it’s not. Leverage is a two-edged sword you can use to cut your own head off if you aren’t careful. Just like trade size, it’s ok to reduce leverage when volatility is up. If you win, you are likely to win big and/or quickly and if you lose, well you won’t lose as much as you would have.

Get Some Perspective

What I want to leave you all with is the knowledge that losses happen and that’s ok, it’s a part of trading. What’s not ok is letting those losses wipe you out or getting discouraged. If you are having a hard time with the market, maybe it’s time to take a step back and get a new perspective. I know it’s easy to get caught up in the day to day grind. Taking a step back to see the bigger picture, take look at a different chart, or reassess the fundamental situation is often the best remedy. Winning is hard enough without throwing money away on bad trades or damaging losses.