Steve Burns - The Ultimate Trading Risk Management Guide

Where you want to be is always in control, never wishing, always trading, and always first and foremost protecting your ass. That's why most people lose money as individual investors or traders because they're not focusing on losing money. They need to focus on the money that they have at risk and how much capital is at risk in any single investment they have. If everyone spent 90 percent of their time on that, not 90 percent of the time on pie-in-the-sky ideas on how much money they're going to make, then they will be incredibly successful investors. Paul Tudor Jones

There is no shortage of entry signals, stock picks, and trading psychology tips, but where are all the risk management books? If you study trading legends you know that risk management is mentioned frequently. This may come as a surprise to people that think billionaire traders are successful and because of their accuracy, assuming that they rarely make mistakes. A significant portion of any successful traders success is carefully managing risk to avoid losing streaks that destroy their capital, or a large loss that blows up their account.

Risk management is often overlooked and frequently underrated, and yet its one of the most important aspects of profitable trading. A trader must develop a system with an edge and have the discipline to trade it consistently with the correct position sizing to be successful. Without correct risk management, no trading system will be successful over long periods, because the first large losing streak with improper position sizing will likely be the last.

The goal of this book is to lay out the key principles of risk management, so you can become proficient at keeping your money safe when trading. Keeping your money safe and maintaining positive trading psychology will increase your odds of profitability so you can actively trade long enough to achieve success.

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Throughout my financial career, I have continually witnessed examples of other people that I have known being ruined by a failure to respect risk. If you dont take a hard look at risk, it will take you. Larry Hite

T raders and investors are drawn to the financial markets because it provides an opportunity to make money. The profit capabilities are uncapped and the barrier to entry is low. Trading is an equal opportunity endeavor and almost anyone can open a brokerage account for a small amount of money. Someone can open an account in the morning and be trading against professionals that afternoon. Your risk aversion will determine if this sounds exciting or like a terrible idea.

Just because you can buy and a semi-tractor trailer and drive it down the Interstate, doesnt mean it wouldnt be incredibly dangerous for you and others. In fact, the barrier to entry on the truck is higher than a trading account. A broker will gladly throw you the keys to your own trading account if you deposit a small sum of money, pay him a low commission fee, and sign a commission agreement. He gets paid when you enter and exit a trade, so he makes money whether you are successful or not. You take on all the risk and they get paid regardless. So, what are the risks?

The trading world is full of pictures of exotic cars and fancy homes depicting success, but you almost never hear about the risks of losing money. The fastest way to lose money is to try and get rich quick. You can lose your trading account with one bad trade if you dont understand leverage or risk exposure. And selling option contracts short with no hedge can cost you more money than you have in your account!

The options and futures markets can be dangerous if you arent properly capitalized or dont understand the leverage these products can provide; they can be all or nothing bets whether you know it or not. Penny stocks that are sold over the counter (OTC) and on the pink sheets can be more risk than theyre worth, because many arent real companies or just pump and dump schemes. Also, the bigger you trade the more liquidity issues you can experience. You can find yourself trapped and unable to get out of a trade or experience large amounts of slippage on exit and entries that cause substantial losses.

There is a big difference between trading with your retirement account savings, trading in a speculative account, and risking capital on all our nothing bets. A retirement account like an IRA, 401k, or 403B should be safeguarded against large risks. Stock indexes are a good long-term vehicle to maintain capital and grow it incrementally year over year with minimal risk. A speculative trading account can be traded more aggressively with individual stocks to try and beat the market, but the best way to grow your trading account is to let it grow over time, slowly compounding your capital.

Risk capital is what traders use for all or nothing bets. You can lose it all, but it wont have a significant impact on your lifestyle or long-term finances. Risk capital is a good designation for most of the trading that goes on with options, futures, forex, penny stock, and crypto-currencies for amateur retail traders. Most trading done by undercapitalized traders in these markets are all or nothing bets, whether they realize it or not. Most options will go in-the-money or expire worthless. Most crypto currencies in 2017-2018 wont be accepted for monetary exchange or go to $0 quickly. Most penny stocks are already under a penny, so they have a shorter trip to zero or becoming too illiquid to exit.

Its crucial to understand the difference in the type of capital youre putting at risk. Do you want to retire with the money? Then its necessary to be careful and grow it slowly because you have plenty of time. Do you want to grow your trading capital into a large account? Dont spend it, leave your profits in and let them grow. Do you have extra money you want to risk on the hopes of a big win? Be careful, there is a fine line between a trader and a gambler. Even if youre doing it for entertainment and understand that you could lose it all, make sure you dont get caught up in an emotional roller coaster of big wins and big losses.

There are two sides to every coin. If you flip a coin over and over, you will get a mixture of results, sometimes heads and sometimes tails. You wouldnt expect heads or tails every time just based on the odds. Trading is the same way, sometimes youll make money and sometimes youll lose money. There isnt a 100% winning system, and the first step on the path of trading success is to realize this fact and stop looking for a perfect system that never loses. Instead, focus on a profitable system that you can let play out over a large sample size of many entries and exits. You must understand that youll have an equity curve that wont always be making new all-time highs, but there will be a path to profitability and managing losses and losing streaks can be the difference between success or failure.