You are allowed to take risk only if you thoroughly understand risk. Since there are so many parameters involved, it is not easy to evaluate risk. Trading is another form of risk. In trading, you risk your money because assets go up and down in value. Sometimes, this risk is not related to your trading performance. This is known as subjective risk. Subjective risk can be defined as the fear that a person attaches to a particular activity. The real risk is the money you lose in a losing trade.
Risk is subjective
People think that futures’ trading is a high-risk job because most futures traders lose money, and as a result, most people stay away from futures trading. People wrongly equate risk with the probability of losing. Successful traders only risk when the probability of winning is high. The goal for any trader has to be taking low-risk trades. For most people, the idea of low-risk trades is “terrifying” because they feel that it is most likely to hurt them.
There are some future and options strategies which are different from traditional investing, and thus used by investors for diversification. Investing only a portion of your portfolio using various strategies can reduce the variability and exposure to risk. The other way used by successful traders to control real risk is by determining exit points before entry, placing stop losses, and most importantly, not risking more than 1% of account size. This is how they do it.
Instead of following the above rules and practices, average traders increase their risk because of psychological issues. Changes in market conditions terrify them. This is why they consistently lose money. They are afraid to add funds to their account for fear of losing it. The worst part is that they are even scared to study the markets as they feel it can waste a lot of their time and energy. At the same time they will not stop trading, because if they stop, they would never get back their money. We can conclude that the average trader does not fully understand risk.
Now let’s understand the risk for short term traders and long-term investors. After a lot of studies, it has been found that there no difference between the two in terms of winning and losing characteristics.
- The primary difference between the two is how long does it take for them to win or lose. Traders who use high leveraged instruments are said to lose their money much quicker than others. On the contrary, they can also win big if they understand risk correctly.
- Risk is the same for every trader. The only thing that matters is how you trade the instrument.
- A speculator has a lot more work to do than a long-term investor, as he is trading every day and cannot repeat those mistakes. Using the “Top Trading Tasks” while trading can minimise risk by a lot.
The Loss Trap
A very powerful and hidden process revolves in risk. It is called “The Loss Trap”. Its basic conclusion is you must be willing to take the loss if you want to win!
We are all taught from our schools that winning is everything or “the only thing”. Taking losses means going against what we learnt. The person who is a loser is not given enough importance. But in the case of trading, it is different. You should be ‘okay’ with losses. Losing is a part of this game. The base of a loss trap in trading is not accepting this basic truth. The more you try to get away from the loss, the tougher the loss trap becomes. There are hidden factors that do not allow the trader to escape from the loss trap. The more the trader resists the losses, the more difficult it is to get away from them.
Whenever a trader makes a loss, he imagines this loss while taking his next trade. When a trader assumes that an asset has made a bottom, he believes that there is no further risk in the stock. Now the stock can only go up. He has built so much confidence in the stock that he will enter the trade without using a stop loss. All this imagination is only taking closer and closer to the loss trap. The only way to not get in the trap is by letting it go, which of course cannot happen. Unfortunately, the trader is already in deep losses before he gets out of the trap.
There’s an old saying – “It’s difficult to be successful in trading if you’re not willing to lose. Almost impossible. It’s like wanting to be alive, always willing to breathe in, but not willing to breathe out.”
A trader, who is ready to accept small losses, can get compensation for them with big wins. But when the loss is unacceptable for a trader, he will not be able to take the loss when he should. As a result, this small loss will turn into a big loss. Not many people can accept this in the long run. But, if they can handle the small losses, they can increase their chances of winning.
This is how a loss trap is created. Hence, to avoid it, you need to learn how to measure risk objectively and how to control risk by proper money management. The secret of handling risk successfully is, to be prepared for any situation. Happy Trading!