Sovereign debt, falling gold prices, Euro worries… there is a lot of talk in the news about risk. However, as a trader/investor, risk can mean something different. There are two types of risk we must face in the markets. The first is considered an opportunity, as seen in the current risk issues facing the global markets that I highlighted above. This risk in the world makes for increased volatility that we can profit from. The second risk we face is the risk of loss in our positions. In fact, when we are trading or investing, the amount of loss we will suffer is the only thing we can control. We cannot control whether we will win or lose in the position as we cannot control the direction of the markets themselves.
To most traders, risk management means simply setting stops. Many investors do not even do this to control risk. However there is much more to managing your risk in the markets. You wouldn’t drive onto a bridge if you have noticed that most of the supports have crumbled would you? Would you walk onto a frozen lake after seeing a “Thin Ice” sign posted and several cracks showing in the ice itself? Of course you wouldn’t, that is because you observed the environment and realized that it was too risky to proceed.
We need to observe the same discipline when we are involved in the financial markets. To analyze risk before trading or investing, we must look at the current market environment, the security’s environment, and the trend. Are we in a danger spot that would preclude us from taking a trade? No one is forcing us to enter into every trade that we see. Suppose the markets were bearish, your security has just released disappointing earnings, and is near resistance on your trading and larger timeframes. Would you buy shares just because prices moved up slightly after a bullish hammer candle? Most likely you wouldn’t. Even though you have a short term bullish signal, the overwhelming bearishness of the… Continue Reading
