Every now and then, it’s a smart idea to take a step back and do a risk management review. I’m sure most of you are well-prepared and on the right track. You have put good trading systems and strategies in place, and you take home more green than red. A review allows you to fine-tune your tactics in a constantly changing environment and/or reinforce what you are doing right.
If you’re thinking, “But I don’t want to take the time to do a review,” stop right there. Over the years, I have seen too many traders blow up their portfolios because they got complacent and sloppy.
Risk management review: are you following these principles?
The markets do not exist to make you rich. They are there to keep you on your toes and teach you lessons. These lessons are all risk management principles:
- Stay in control
- Be disciplined
- Remain humble
If you can follow these principles, you’re going to be in the game for a long time.
And that’s what this is about, right? As a trader, you don’t have job security. Each trading day, you are at risk of being fired. I don’t want to be fired, so here’s how I put these risk management principles into action:
Only trade with discretionary capital, aka, what you can afford to lose. Not many traders have a huge pot of cash to spare, so that makes the choice to trade much harder. Establish a sound risk strategy and don’t violate it, no matter how wide-eyed you get over the opportunities in front of you.
Avoid shooting the ball when the hoop looks very wide. This is often when disaster strikes. Take it from me: Trying to recover from a trading disaster is a painful experience. Place smaller trades and take profits when you have them.
Set aside a percentage of your account for trading. A modest 2-3% of your account is plenty to work with for leveraged vehicles like options. For stocks, up to 10% of your account is sufficient. Always keep cash on hand, and always have some protection in place via index puts.