We all have different personalities; some people are very extrovert while others are shy and retiring. Some people thrive on taking risks while others want guarantees on everything before they are prepared to make a decision. And even if they do take a risk, they want to sue someone if it all goes wrong!
My guess is that if you have got this far with your interest in trading, you are prepared to take some risk at least. If you are not prepared to take some risks then I suggest you put this book down, pick up a novel, make a cup of hot chocolate and get an early night!
The trouble with risk in trading is that unless you have some experience of trading AND LOSING, particularly losing an uncomfortable amount, you will not know where your risk threshold is.
The amount you worry about things will determine how you view a trade before you even take it on. It also determines how you will react if a trade begins to go against you.
If you are a worrier you could also have real doubts about your strategy if you get three or four consecutive trades that don’t work out – you will not have the confidence to continue and let the law of averages work over a longer period.
You could also be tempted to take a profit and run in case the trade turns against you instead of sticking to the strategy that could make an even larger profit. Patience is important in trading. Sometimes things just don’t happen when you want them to.
Risk and reward are inextricably linked. It is absolutely true that the more risk you take, the more POTENTIAL reward you might get. BUT:
- Only if the risk is one you can feel comfortable in taking or you will override your strategy.
- There is no point in wiping yourself out with two or three trades that don’t work out.
The more risk you take, the more worried you are likely to be and therefore the more you are tempted to make an emotional decision rather than stick to your strategy. Trading decisions based on emotion rather than a set of rules (strategy) will ALWAYS get you into trouble in the end.
Sometimes you will be lucky and your hunch will be right. Unfortunately, that will lead you to make even more emotional decisions and at that point you might as well forget any strategy completely and trade on instinct and emotion.
Trading emotionally is a recipe for disaster. Greed and fear and the traders worst enemy.
There is a great saying in trading, ‘Cut losses quickly and let your profits run’.
Traders who let losses run get wiped out quickly. Traders who take profits early get wiped out slowly but BOTH will get wiped out.
The trick is to develop a strategy that allows you to control losses and get the most out of your trades on a consistent basis and then stick to it. Believe me, sticking to it is far easier said than done. Your emotions will often conflict with your strategy but if your emotions win you might just as well forget the strategy.