Becoming a Great Risk Manager w/ John471

Becoming a Great Risk Manager

If you have been a trader for any length of time, you’ve likely made two critical mistakes: You have probably had a good day, or week, and then projected those results out over a year, fantasizing about how great it will be in a year when you have generated that much revenue. You have probably also found yourself aggressively trading a market with little opportunity, attempting to get what you think you should, out of a day that has little to offer and ended hitting your Daily Loss Limit (DLL).

One thing we have discussed quite a bit here at Convergent is how variable the opportunity (and risk) is from day to day in this business. The market can easily go from a clear, easily moving trade that hands you your favorite setups regularly, to a boring, tricky, choppy mess that leaves you questioning everything about yourself and your chosen career path. You may have heard me remark that on days like that, it is important to be a great Risk Manager.

So, what does being a great Risk Manager actually mean? Here are my key points for superior risk management:

Know Your System and Your Edge

Knowing your best and strongest trades, and under what circumstances they may or may not show up, is key to your development. Your best trades are often not the ones that show up the most, but often are the ones with the best R-Factor (R:R Ratio), clearest signal, and it’s easiest to know when you’re wrong. These trades may not offer the tightest stop because the stoploss is probably based on a price level derived from market structure, i.e., a key inflection point for the day. But, if they work, they capture your key idea for the day. These are core to your system, and when the market is difficult, you should focus only on these.

Know Your Expectations for the Day

Did we just have a huge move and are opening in range, with low ON range and volume? Or has range tightened for 2 weeks straight and suddenly we are opening gap lower 20 points, beyond a key reference? These two circumstances foreshadow two very different likelihoods for what a day may give us. It is important to know the difference. It is important to know if this is a day that will likely give you multiple setups, and the chance to come back if you take an early stop, or is this a day that is very unlikely to have any real movement, and an early stop could be an indication that the market is not moving in a way that is comfortable to you? Learning to differentiate and react accordingly is a key trading skill.

Know Yourself

What are you bringing into the day? Are you on a streak…is this something that has affected you in the past? Did you hit your Daily Loss Limit (DLL) yesterday? Did you have your best day ever yesterday? The emotion that can arise from these conditions affects the way we perceive the market in real time. It is important to be aware of this effect and to know if you are trading an emotion or desire, versus trading a setup/price action. Most of our major trading setbacks don’t come from poor market action, but from trading based on our desires rather than strategic setups/price action.

Don’t Be “That Guy”

Above all, don’t be “that guy”: A challenge we face trading from home is we do not have the office atmosphere, where the mood of other successful traders helps even us out, and gives us an example of how to model our behavior. It’s easier to make ‘rookie mistakes’ at home, when all you have to worry about is losing money and not the embarrassment of making mistakes in front of peers. Know the foolish rookie mistakes, and don’t make them. Don’t hit your Daily Loss Limit (DLL) in the first 15 minutes of the day, don’t overtrade at obviously poor times such as: the day after Nonfarm Payroll (NFP), the morning before a Fed Release, etc. Don’t continually fade obvious trends. Don’t waste all of your bullets on one idea. In short, if it’s obviously wrong, and you know it’s wrong, don’t do it.
Review these points, then think of times in your own trading when you know you were not a good risk manager. Remember that no matter how prepared you are on any day, you can only take what the market gives, do not risk more than what is appropriate given the expected return, and in doing so, always protect your business first.

– John P. (@John471, ES Market Maven at Convergent Trading)

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