Series: What’s in a Trading Strategy – Risk Assessment
Most marketers of trading methods spend a lot of time telling you how to get in the market. (They also spend a lot of time telling you how great their methods are but that’s a discussion for another posting.) Volumes are written regarding the perfect setup, the perfect entry, the perfect execution of a trade. These approaches treat trading methods like on/off switches. The setup conditions exist means on, if not, off. If you don’t have a setup you don’t place a trade. Although the absence of a setup is a common sense answer to avoid trading, it is not the only reason to stand aside. Once you have a tradable opportunity, now you need to determine if it is a good opportunity.
Since all decisions require an emotional commitment, the need to feel good about a trading decision is very important. There are two ways of accessing a trade’s viability; internally and externally. An internal point of view looks at the trader and their state of mind. I’ll talk more about this in the next installment. Risk assessment addresses the external considerations for qualifying if a trade setup is a good one.
Not all opportunities are created equal. If that were true, the act of trading would be much easier. Hence, in my coaching practice I’ve had hundreds of conversations that sound something like, “I followed the rules, but the trade went against me. The strategy said this was a setup. What did I do wrong? Where did I miss read the rules? Can you explain the trading rules to me again?” Bright, intelligent, well-educated, successful individuals become completely befuddled following a simple set of rules. This is akin to being able to fly an airplane but can’t follow instructions to scramble eggs. It’s no wonder that frustration levels are very high.
Assessing the risk of a trade is vital to your success as a trader. Traders need to be very selective about which trades are worthwhile. This is due to the fact that methods are designed to take advantage of specific market conditions. If the market doesn’t cooperate, then the method is going to fail. The responsibility falls on the trader to determine if this is the right market to trade.
So here are some questions to consider just before you enter the market:
- Is this trade worthy of my money?
- Are there any upcoming news announcements that could affect my trade?
- Does the stop placement and target seem reasonable?
- Are there any historic price levels I need to consider that could effect my trade (i.e. support/resistance, trend lines, price patterns?)
- What is the relationship between my price target (or my expectations for the trade) and historic price action?
At the end of the day, this is your money. The trading method you spent money on or the advisory service you pay a monthly fee isn’t going to reimburse you for bad trades (if one exists, please let me know.) Trading should be about choices in line with your values. The clearer you can be about your choices, the happier we will be with our trading results, regardless of the financial outcome. Better decisions will lead to better results over time, and keep you trading longer.