Psychology and Risk Management
• What to expect
• Risks
• Position sizing
• illusion of control
• Accepting critisism
• Paralyzed by fear
• Loss is a feedback, not a failure
• The flexible trader
• Focusing on the positive
• Short straddle
• The dynamics of greed
• The herd mentality
• Notes
You make routine judgments throughout the day that don’t really matter to you. Choosing which route to take, where to turn, and when to stop for gas are just a few of the choices you must make when you transport your children to school. Each choice is made without much consideration. You might opt to visit the grocery store at a later time. You select the dinner menu and determine your budget. Do you fret over these routine choices? Most likely, you don’t. Just why would you? Why all the fuss? The decisions’ effects are essentially nonexistent. But don’t say that to a person who suffers from OCD.
They view the importance of these choices from a different angle. For those with this condition, even seemingly unimportant daily choices have a tremendous impact. Don’t you feel relieved that you do not suffer from OCD? However, if you are a novice trader who struggles to make trading judgments, an experienced trader might assume you suffer from an obsessive-compulsive disease of some sort. Because you are impatient or frustrated, you sell early or forsake your trading plan, yet experienced traders have no trouble making what they view as routine decisions. To them, it’s just a decision that needs to be taken; it’s not a huge thing. Isn’t it lovely to trade in such a liberated and simple manner?
It is far preferable to adopt a more impartial, objective stance. How do you manage it? First of all, resist the need to dwell on or become fixated on a single trade’s outcome. Consider the big picture. If you have a trading technique that has a high probability of success, even if you might lose one transaction, over the course of several deals, you will come out ahead. Instead of making a small number of important trades, successful traders prepare to execute many smaller trades. They are aware that not every trade must be profitable in order to raise the equity in their accounts as they trade.
Your total achievement is what matters. It relieves some of the pressure to remember this. Second, effective risk management is crucial. Only a small portion of a trader’s trading money is at risk in a successful trade. Limiting the risk on a single trade also eliminates some of the feeling that each trade must be successful, which lessens some of the significance for the trader.
It’s not necessary to give a trade a lot of personal value. What’s the big deal if you only risk a certain amount of money on a trade, limiting the actual repercussions of the trade as a result? Trading should be simple and free.