Trading Software and Books Reviews

Are You Really a Risk Taker?

Very early on, in 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 that 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. A large number of new traders seek out multiple technical indicators, in essence, searching for multiple layers of assurances for their trades. The problem I see with this set of criteria is 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 or 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 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 they’ve just received a body blow. Some students begin to take every loss personally. While with others, I have to suggest they step back and take a deep breath before they continue their trading, as they’ve become overwrought, and are no longer thinking logically. It’s at this juncture when students really find out how they emotionally react to losses. 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, 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 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 breakeven level, this trader will close out the trade, relieved he didn’t lose money. Invariably though, as soon as he exits at breakeven, the trade goes on to do exactly as his analysis suggested – causing him 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’ve covered the risk/reward topic in previous newsletters so I won’t go into it now. However, 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 to win. He understands that aside from the initial ante, he only presses his bet when the odds are in his favor. What’s more, he understands that he may not win for a series of hands, but if he plays enough hands, his edge will win out over time. Similarly, the professional trader will put on his trades in a systematic fashion without FEAR of losing or being wrong. He sees every trade as only one in a series of hundreds or possibly thousands in his 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 that 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 your profit target is attained. 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.

Until next time, I hope everyone has a profitable week.

Gabe Velazquez, Online Trading Academy E-Minis Instructor

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