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Mastering Risk and Reward in
Trading |
Mastering Risk and Reward in Trading
Not mastering risk and reward in trading is probably
the main reason why so many traders and investors are
destined to fail. It's really dumb when you think about
it, because reward/risk is the easiest way to get a
definable edge on the market house.
The reward/risk equation builds a safety net around your
open positions. It's designed to tell you how much can
be won, or lost, on each trade you take. The secondary
purpose is to remove emotion so you can focus squarely
on the cold, hard numbers.
Let's look at 15 ways that reward/risk will improve your
trading performance.
- 1. Every setup carries a directional probability
that reflects a specific pattern. Always execute
positions in the highest-odds direction. Exit your
trades when a price fails to respond according to
your expectations.
- Every setup has a price level that violates the
pattern. Only take trades where price needs to move
a short distance to hit this "risk target." Look the
other way and find the "reward target" at the next
support or resistance level. Trade positions with
the highest reward target to risk target ratios.
- Markets move in trend and countertrend waves.
Many traders panic during countertrends and exit
good positions out of fear. After every trend in
your favor, decide how much you're willing to give
back when things turn against you.
- What you don't see will hurt you. Back up and
look for past highs and lows your trade must pass
through to get to the reward target. Each price
level will present an obstacle that must be
overcome.
- Time impacts reward/risk as efficiently as
price. Choose a holding period based on the distance
from your entry to the reward target. Then use price
and time for stop-loss management. Also use time to
exit trades even when price stops haven't been hit.
- Forgo marginal positions and wait for the best
opportunities. Prepare to experience long periods of
boredom between frantic surges of concentration.
Expect to stand aside, wait and watch when the
markets have nothing to offer.
- Good setups come in various shades of gray.
Analyze conflicting information and jump in when
enough ducks line up in a row. Often the best thing
to do is calculate how much you'll lose if you're
wrong, and then take the trade.
- Careful stock selection controls risk better
than any stop-loss system. Realize that standing
aside requires as much deliberation as an entry or
an exit, and must be considered on every setup.
- Every trader has a different risk tolerance.
Follow your natural tendencies rather than chasing
the crowd. If you can't sleep at night, you're
trading over your head and need to cut your risk.
- Never enter a position without knowing the exit.
Trading is never a buy-and-hold exercise. Define
your exit price in advance, and then stick to it
when the stock gets there.
- Information doesn't equal profit. Charts evolve
slowly from one setup to the next. In between, they
emit noise in which elements of risk and reward
conflict with each other.
- Don't be fooled by beginner's luck. Trading
longevity requires strict self-discipline. It's easy
to make money for short periods of time. The markets
will take back every penny until you develop a sound
risk-management plan.
- Enter positions at low risk and exit them at
high risk. This often parallels to buying at support
and selling at resistance, but it can also be used
to trade momentum with safety and precision.
- Look to exit in wild times in order to increase
your reward. Wait for price acceleration and feed
your position into the hungry hands of other traders
just as the price pushes into a high-risk zone.
- Manage risk on both sides of the trade. Focus on
optimizing entry and exit points and specialize in
single, direct price waves. Remember that the
execution of low-risk entries into bad positions
allows more flexibility than high-risk entries into
good positions.
Mastering Risk and Reward in Trading |
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