How To Avoid Mistake "Failure to Control Risk" in Trading?
The only way to avoid Mistake "Failure to Control Risk" is to plan carefully regarding the types of risk control needed for the type of trading that you are going to do and then to employ these controls without exception. Risk control falls into several categories. Some are inter-related but each can play a crucial role in ensuring a long trading career. Before going into details let's first define the role of risk control in futures trading.
The ultimate goal in trading futures is to make money, the more the better of course. However, the trade-off that needs to be considered is the relationship between total profitability and the volatility of the performance along the way. No matter how profitable a particular trading approach may be, if the day-to-day volatility of returns is too great there is a chance that you may stop trading too soon, due to either a lack of trading capital or a lack of emotional wherewithal.
As an example, consider a hypothetical trading method that makes 1000% one year and then loses 80% the next year and so on and so forth. The good news is that after 5 years a $10,000 account would be grow to $532,400—a phenomenal 121% average annual rate of return. That's the good news. The bad news is that between years one and two the account equity would plummet from $110,000 to $22,000 and between years three and four the account equity would fall from $242,000 to $48,400, before zooming to $532,400 in year five. How many traders would actually continue to take every trade given a roller coaster ride such as this? Estimated guess: zero.
Many traders start out saying "if I have to sit through a 30% drawdown, no problem, because I know my approach will make a lot of money in the end." Unfortunately, about 25% into that 30% drawdown about 90% of such traders decide they can't take it any more and they pull the plug, thereby missing the rebound that would have made them whole again.
The long-term goal of employing any risk control technique is to help keep you in the game long enough to reap substantial profits. The short-term goals of risk control are to:
- Reduce the amount of risk you expose yourself to at any given point in time
- Minimize the amount of volatility you experience on a day-to-day basis to a level you can live with and keep trading through
If you can sleep with the level of fluctuations in your account you are far more likely to stick around for the long haul. At the same time you don't want to forego a large portion of your upside potential in the process just to achieve a smooth equity curve.
Anything that reduces the magnitude of equity drawdowns goes a long way towards keeping a trader in the game for two reasons. First, it reduces the amount of money lost at any one time, thereby reducing the risk of ruin. Secondly, it can relieve a great deal of emotional pressure for the individual trader, which in turn makes him far less likely to do something drastic in the face of a sharp drawdown. The costliest mistakes in trading are usually made when the pain of losing money (and/or the fear of losing more money) becomes too great. It is the number one cause of bailing out when you should be staying in, doubling up when you should be cutting back, tightening stops arbitrarily (thereby guaranteeing that they will be hit), widening stops arbitrarily (thereby guaranteeing an even bigger loss on the open trade), etc., etc.
There are several risk control methods that can make a difference in your trading. You should very carefully consider the potential benefits derived from implementing each method.
Categories in Trading Mistakes
Lack of Trading Plan
Planning plays a key role in the success or failure of any endeavor
Using too much Leverage
Determining the proper capital requirements for trading is a difficult task
Failure to control Risk
Refusing to employ effective risk control measures can ensure your long-term failure
Lack of Discipline
A lack of discipline can destroy even the most talented and best prepared trader
Useful Advices to Beginning Trader
You can control your success or failure
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