Minimize Your Trading Losses And Master The Markets
Because it's a fundamental principle of money management, one cannot neglect to define one's trading float as well as one's maximum trade loss. By def...
Because it’s a fundamental principle of money management, one cannot neglect to define one’s trading float as well as one’s maximum trade loss. By defining our maximum trade loss prior to actually trading, we can ensure we keep losses at an absolute minimum. Likewise, our maximum trade loss should only account for a tiny portion of our trading float in order to safeguard ourselves in the event of multiple losses.
Unacceptably high risks are the primary reason for so many traders failing. Remember, the objective here is to keep losses at a minimum while at the same time allowing ourselves enough room for profits.
A very famous cricket captain once said that the most important aspect of the game, is not to make runs, but to stay in the game. I mention this because it’s so true with regards to trading as well. Your primary goal should be for you to protect your trading float just as that captain sought to protect his wickets. If you loose your float, you’re out of the game.
Always being aware of the maximum loss I’m willing to accept, doesn’t mean I’m negative. Instead, because I employ a meaningful trading psychology, I’ve learnt to be on the defensive at all times. After all, it’s all about survival.
Being a firm believer in keeping trading losses to a minimum, a top trader by the name of Ed Seykota once defined the 3 elements of trading. He said,”Follow these three rules and you just have a chance”, 1) Cut your losses, 2) Cut your losses and 3) Cut your losses.
Whether you like to believe it or not, you will experience losses along the way and there is nothing you or I can do to avoid them. However, the trick is to accept them and then to move on. Whatever you do, never allow losses to obscure your better judgment because in trading, keeping a clear head is vital.
What is the ideal maximum trade loss? According to many studies, the ideal figure seems to be 2% of your trade float, hence the well known 2% rule in trading. Of course there are also scores of professionals who refuse to risk more than 1% of their float on any one trade. Remember though, while this certainly minimizes the effect of any losses, it also means your profits won’t be very big.
Perhaps a better way of putting the 2% rule into perspective would be for me to use an example. So, let’s say we start out with a float of $20,000 to which we apply the 2% rule. In this case our maximum loss on any given trade would be $400. As you can see, with your losses kept this low, it would take many losses to erode your float completely.
In fact, we would need to experience no less than fifty consecutive losses before loosing our entire float. Of course, you don’t need me to tell you just how unlikely it is that you’ll experience 50 losses in a row. Furthermore, because the 2% rule actually uses the current float amount rather than the initial float amount, you would need even more than fifty losses before being broke.
Let’s see how the 2% rule is applied:
Starting with a $20K float we have our first loss based on the 2% rule. As we know, this would me we loose $400 which in turn leaves us with $19,600. Once again, we apply the 2% rule on our next trade, thus meaning the maximum loss we expect would be $392. Now let’s see what happens when life treats us really bad and we experience a string of six losses:
Float amount: $20,000
Float after 1st loss: $19,600
Float after 2nd loss: $19,208
Float after 3rd loss: $18,824
Float after 4th loss: $18,447
Float after 5th loss: $18,079
Float after 6th loss: $17,717
Even after six consecutive losses, we’re still left with $17,717 in our float. If you ask me, this is what I call, “Risk Management
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categories: traing risk management, trading rules, trading, business, finance
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