You may not have noticed…………….but, this trading stuff is risky.As a student of trading, I have to admit, publicly, that I found the truth to the above statement the hard way. (Is there any other way?)

Here’s what I was recently told, by my mentor:
“Winners focus on RISKS.
Losers focus on PROFITS.”

NOW he tells me! (In Texas, we call it closing the barn door after the horse has gone.)

As I look back on my beginning trading and as I speak with many starter students of trading, I see a definite pattern: They are thinking of making a PROFIT, they look at how much they could MAKE on a trade and they are not REALLY aware of the full RISKS that they are taking on, especially in relationship to their portfolio size.

How does this happen?

Here’s my take on the matter:

Many students want to make more money than is reasonable for their portfolio size. Likewise, they want to make it faster than is reasonable and realistic.

Thus they make several mistakes:

1. They ignore the fact that there are PORTFOLIO MANAGEMENT RULES which are well-documented, established and proven thousands of times to hold true.

They make the common error of thinking, “I’ll be different” or “Yes, but my situation calls for more aggressive action.” I’m sorry to say, ladies and gentlemen, but both are death knells and lead to NON-survival of the learning curve. They lead to action and attitudes that are more gambling than trading. They somehow, deep within their minds, rationalize that those rules do not apply to them. But they do. They DO!

2. They don’t know how to correctly analyze a potential trade for the true risks involved.

They don’t consider the fact that ‘anything can happen…and will!’ They don’t learn how to place the trade on a risk graph and to SEE, not just LOOK, at how much exposure they’re taking on. And, worst of all, they don’t consider the ‘Black Swan.’ The Black Swan is defined as being the worst possible thing which can happen, the thing that no one believes will happen and that, when it happens, pundits say, ‘It was easy to see it coming!’

As another example, suppose the trader forgot about a put option he had sold and it ended up, on expiration day, in-the-money? Would he be shocked if the next Monday morning, he looked at his screen and found that he owned hundreds of shares of stock and his account had been debited for thousands of dollars?

3. They attempt to fix a defined risk trade with an unlimited risk ‘adjustment.’

This is where they might place a spread, for example, a short call vertical (bear call), the market rallies, so they sell a put to offset the loss in the vertical. What happens, in this case, is that they have UNLIMITED downside exposure that could lead to ‘sudden death’ to their portfolio.

Here’s my trading psychology on placing a trade:

a. Ask what the Black Swan RISK is and EMBRACE that odiferous bird, i.e., be sure you’re financially, mentally and emotionally comfortable with that much loss.
b. Define what your MINIMUM profit level is so that, when that’s hit, you can GET OUT and take your RISK off the table as soon as possible.
c. If the trade goes against you, FIRST consider simply reducing your RISK in the play.

The committee of ‘they’ says, “Focus on RISK reduction, avoidance and minimization. Eventually, you’ll actually start to see some profits!”

I concur.

Let’s survive our learning curve together by watching our risk at every turn!