A taste for risk

The single most essential factor for us to understand once first starting to trade is risk management. Of course we all would like to trade to bring in money. So the essential thing we need to be taught is not to lose it. Of course you will experience losing trades, we all do, it is part of trading, it is inevitable. But learn to handle those losses and thereafter endeavour to minimise and keep on minimising them.

With this in mind I confess to being intrigued by the wildly dissimilar approaches proposed by various people. Some will tell you to swing trade so that you can capture whichever sizeable swings that occur in the course of the day. Their argument is that by doing this they will not lose out on any major movements that take place. They take advantage of significant stop losses to allow the trade a chance to breathe, as they say. This way they can allow the trade run and run for a nice long stretch and gather in a nice high profit. They do not need to stay chained to a PC all day long and are comfortable in the knowledge that a large stop loss allows them to trade in this way. And certain individuals do exactly this.

Let us consider the amount they are risking. Suppose for example the pound is falling against the euro and the chart shows the price bouncing down and up against say the 40 daily moving average. Let us presuppose that our stop loss is trailing barely above the 40dma.There could well be a difference between the price and the stop loss of say 2-400 pips. That is one heck of a lot of risk! You need very deep pockets for this method.

Another method that the risk adverse beginner may perhaps want to consider is somewhat different. Imagine the chart described above. Instead of being a daily chart it is a 10-minute chart although we will take for granted its appearance is much the same. Because the price variations are smaller the risk is much smaller. Being a smaller time frame it will need closer monitoring than a swing trade but this is a balance that needs to be struck.
It often amazes me that certain traders will let a trade rise to its summit and afterward let it retrace in the hope that it will take off again to a higher peak. This it might or might not achieve. When a price reaches its high point it is surely prudent to exit the trade at the earliest obvious sign of a reversal and to re-enter afterward. By following such an approach the stop loss, instead of being placed on a moving average can be placed at say the low of the preceding bar. As a consequence the risk is reduced to a very low level and fulfils one of the criteria outlined at the opening of this article. In order to continue to reduce the risk element you may well find you can reduce the stop loss to a portion of the proceeding bar so instead of having a 200 pip stop loss you can perhaps get away with say 20. Now that is low risk.