Secret #5 - How To Control Risk

hammer Of "The Five Secrets You Must Know To Make Money In Stocks," Risk Control is definitely the most important. Although most people ignore the dangers of market risk, neglect in this vital area is the main reason that more than 80% of all individuals lose money in stocks.

You have to take risk to make a profit, yet you always want to be sure that the risk is reasonable. You also want to apply measures that prevent any losses from seriously injuring your trading account.

To accomplish this, you must be willing to minimize all losses quickly - even when you don't want to. No one likes to lose, but the first loss is always the cheapest.

- - - - - - - - Pages Index - - - - - - - -
The Five Secrets: Intro
How To Pick The Best Stocks
How To Pick The Best Stocks - Part 2
How To Win In Any Market
How To Enter & Exit at the Right Time
How To Maintain A Winning Edge
How To Control Risk
The Five Secrets: Conclusion

-- Planned Losses vs. Unplanned Losses

There are two types of losses - planned and unplanned. An unplanned loss is the familiar, common type that all new traders experience. It happens when a trade unexpectedly moves against them, and they have made no previous plan to deal with it. The loss continues to grow until it becomes an ugly problem.

A planned loss is entirely different. A planned loss gets you out of a loser early enough to prevent any serious damage. Instead of making you feel nauseated, a planned loss leaves you calm and confident. Why? Because you made an intelligent decision and took the appropriate action.

scales It's always smart to take a planned loss that won't seriously injure your trading account. It's never acceptable to let a small loss grow into a large one.

If you have a problem accepting losses quickly, try viewing them as a form of insurance. Small, planned losses are the premiums you pay for coverage. This way planned losses are no longer emotionally painful failures they're just routine costs in a profitable business.

-- The Basics Of Risk Control

There are two factors that should always be included in a complete Risk Control plan.

1) An Exit Strategy that minimizes losses. We've covered this in section #3 - "How To Enter & Exit at the Right Time."

2) A Money Management method that utilizes Position Sizing tactics.

A well-planned Exit Strategy minimizes losses for any one trade. Position Sizing keeps a series of losing trades from causing you serious financial harm.

-- Position Sizing The Key To Risk Control

hold coin One of the most effective ways to control risk is through Position Sizing. Some people refer to this as "Money Management." No matter what you call it, this vital technique is used to decide how much of your trading capital to put into each position.

In effect, Position Sizing vaccinates your investment capital against an inevitable virus - the extended losing streak.

Although some folks are foolish enough to think they can permanently avoid losing streaks, consecutive losses are a natural consequence of the laws of probabilities. Even the best traders experience them.

-- The Odds of Streaks

The simple act of flipping a coin goes a long way towards explaining "streaks." While the odds of each flip turning up a heads or tails is fifty-fifty, a series of 100 flips will produce several winning and losing streaks of surprising length.

raining coins Try it and you'll likely find periods of ten or more consecutive winners or losers. After your first 100 coin tosses, try another hundred. The more flips, the more likely you are to see longer streaks.

Winning streaks are easy for all traders to accept, while losing streaks usually create psychological distress. There are two reasons why it's very important to understand the math behind losing streaks:

1) Traders and investors tend to abandon otherwise successful strategies because they experience a losing streak and don't understand why it's happening.

2) Risking too much on each trade allows an occasional - yet normal - losing streak to seriously damage a trader's capital.

-- The Myth and The Math

fax The common market myth accepted by most individuals ignores the math. In fact, there's hidden danger in the math of losses that usually isn't revealed until it's too late.

Lose 20% and you have to make 25% to get it back.
Lose 30% and you have to make 43% to get back to even.
Lose 40% and you have to make 67% to get your money back.
Lose 50% and you have to make 100% to get back your losses.
Lose 60% and you have to make 150% to get back to square one.
Lose 70% and you have to make 233% to get back where you started.
Lose 80% and you have to make 400% to get . . . . . . . . Get the picture?

-- A Simple Yet Powerful Way To Size Your Positions

Although there are a large number of complex methods you can use for Position Sizing, a simple - yet very powerful - strategy is to risk a small percentage - say one or two percent - of your total trading account on each trade.

Note that the amount you are risking is not the same as the amount of the stock purchase. If the total value of your trading account is $25,000 and you risk 2% of that, your risk for each trade is $500.

symbols Let's say you buy 137 shares of a $45 stock. Your initial position value for that trade would be $6185. However, if the price drops by $3.50 per share, your $500 of risk is gone. At that point you would immediately exit the position.

Since Position Sizing requires crunching a few numbers, a Risk Control Calculator can make the job much easier and faster.

-- The Bottom Line of Risk Control

Similar to flipping coins, strings of losers often occur in trading - even when the odds are in your favor. When used as part of an overall Risk Control Strategy, Position Sizing keeps this mathematical fact from crushing your capital.

Knowing how to control risk allows us to continue trading confidently despite running into a series of losers that would knock most traders off their feet.

Risk Control not only protects traders from financial damage, it prevents the associated emotional damage as well. Most people choose to ignore market risk. Though some are "lucky" for a while, eventually the odds catch up with them.

All traders and investors should have a sensible and clearly defined Risk Control Strategy working on their behalf.

The RightLine Report for Active Traders uses Risk Control on every trade so YOU can eliminate unplanned losses.


"I Want To STOP Dangerous Risk Now!"