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RISK MANAGEMENT TWO QUESTIONS TO ASK BEFORE YOU ENTER ANY TRADE By Brian Shannon 10 TraderPlanet Digital Journal
o one wins in the market all the time. In fact, some of the best traders only win 55-60% of the time but still make great returns on their capital. I myself have had months where my win rate was only 45% but I still netted a profit. There is only one way to make that math work and it is quite simple, your winning trades have to be larger than your losing trades. The mantra "cut losers quickly and let winners run" is a basic principle that we have all been taught and for good reason. Risk management needs to be the cornerstone to any approach in the market, it is simply too difficult to come back from large losses to repeatedly take big risks in the market. For me, it is an obvious choice to swing trade in the direction of the primary trend, which I identify on a longer term timeframe such as a daily chart for 150-200 days. Once the trend has been determined I then want to look to an intermediate term timeframe to come up with my trade plan (establish risk/ reward) and then a shorter timeframe to fine tune the entry into the trade. Listen To The Market We need to have a plan that is based on a reasonable expectation of success relative to the perceived risk. To me one of the strongest reasons to utilize technical analysis is that it allows us to determine our risk/ reward prior to entering a trade, thereby putting our money at work in the positions where the opportunities for profit appear greatest. As I often point out, "If you fail to plan, you plan to fail." —Ben Franklin Only Price Pays Of course, we would like to have an approach where our win rate is as high as possible but markets don’t always agree with our analysis and as frustrating as it is to get stopped out of trades we had high hopes for, hope doesn’t pay the bills, only price pays. Consistent success in the markets is obtained by having an approach which controls risk in the trade from the onset, has the potential for large rewards and is implemented with discipline. coming up with a risk/reward ratio is what programmers would call "garbage in, garbage out" meaning that if we are not objective about our analysis or if our interpretation of the action is flawed, the theoretical risk reward ratio we determined is useless. The best way to come up with a risk reward ratio is to "listen to the message of the market." TraderPlanet Digital Journal 10