c17 JWBT016-Busby September 30, 2008 14:43 Printer: TBD
CHAPTER 17 Risk Management
G
ood risk management is critical to any trading strategy. A bit of
advice that the experts always give is to cut losses quickly but let
winners run. That sounds simple, but it is one of the most difficult
aspects of trading. I have heard it said that if the right risk management
techniques are used, it is possible to make money with almost any strat-
egy. I do not believe that is true, but I certainly believe that without risk
management, any strategy is doomed to fail.
Every trader will make losing trades. Professionals make them all the
time. However, when a professional makes a bad trade, he knows how to
limit the amount of money he loses. An amateur will hold a losing position
and allow his trading account to be bled dry. For that reason, I have sev-
eral techniques that I recommend to my students and that I use myself. By
using these techniques on a regular basis, you are able to hold losses to
reasonable limits.
The first step to managing risk in general is to determine your per-
sonal risk tolerance. Some folks have more money than others. They may
be able to lose $100,000 and not feel much pain. However, another trader
may feel extreme pain when he loses a few thousand dollars. A friend of
mine recently explained to me his strategy for trading precious metals. I
asked about stop/loss placement for his trades. Frankly, the amount of risk
seemed a little high to me and I asked about it. “Isn’t that too much risk to
take?” He leaned back in his chair and smiled, “Not for me.” I understood
the message. He was financially resourced enough to bear that risk with-
out working up a sweat. Furthermore, his strategy was a good one and it
was consistently paying him. Traders with less cash should not be using