BarroMetrics Views: Change of Behaviour
Today I received a number of e-mails following a successful presentation on the weekend sponsored by CMC. I normally ask for a critique of my talk - looking for negative feedback as a tool to improve the next time I give one.
Basically the e-mails revolved around one theme: how can I do what I know I ought to do? Although the posts did not go into enough detail for me to come to a firm conclusion, I believe most of the writers were asking: how do I ensure I exercise risk management?
In my talk, I said that risk management comprises of trade management and money management. Trade Management deals with tools and principles that protect and increase our capital; the most important element of money management is position sizing. The two are inevitably linked.
I define Risk as the difference between my perceived expectation and reality; I define risk management as optimizing the maximization of profitability with the minimization of risk of ruin.
Most newbies makes some fundamental mistakes in their exit strategies and position sizing. As a result 92% have to either bow out of trading or augment their starting capital within 10 months of opening their account.
Some fail to have any exit strategies for each and every trade. Pete Steidlmayer, whom I credit for much of my success, would disagree with me when I advocate that all newbies place a price stop in the market. Pete took the view that exit strategies should be based on changed market structure not on price. I agree with him.
But I have also found that for most newbies not placing a stop is akin to inviting a blowout. For this reason I advocate a price stop in the market for every entry - at least early in one’s trading career.
But, the posts ask, how do we do this?
In my view, failing to place a stop is a result of failing to accept that on a trade by trade basis, the market is random and uncertain. We don’t know what the market will do on this trade. For this reason, we need to pre-accept the loss. This is easier said than done, of course. The best way I know around the problem is to create a habit of placing our stop each time we enter.
In my Habits of Success Course, the equity journal that I ask students to keep involves a 4-step process:
- Assess the risk
- Assess the core profit exit
- Assess the reward to risk (is the trade worth taking given our trading history)
- Assess the first-third exit (Rule of 3)
Part of the process involves a visualization of how we would feel when stopped out. Note I say ‘when’, not if. The process assumes we’ll be stopped out and we ‘practise’ managing our feelings when that occurs.
The students that follow this plan, find that placing initial stops becomes a habit. A number have told me that they could not now imagine being in a trade without protecting their capital.
So, what do you think? Would this process help you or would it have helped you early in your career?
Refer this blog post to a friend or colleague…
