Trading Survival 101

Crude Oil Chart (click on chart to view)

Today was tough trading with a slow gradual decline in the market throughout the day. In hindsight the trade for today was get short at NYMEX open and flat at NYMEX close.

However that is easy to see now.

How does a trader survive periods like this, when the signals are getting stopped and the winners are not running?

Risk Management.

A sound risk management policy is required by all traders to preserve capital, as a trader without capital is a trader looking for a job. This is the most important policy in the start up phase of the trading business. Without sound risk management rules, and adherence to those rules the business will not survive.

Our thesis for the risk management policy is based on the principal that capital is scarce. If capital was not scarce it would have no value. We are willing to accept the trade off of lower overall returns by not trading all signals if we have hit our daily, weekly, or monthly stop in order to reduce our “risk of ruin”.

One of the key success factors of the successful trader is sufficient capital. The risk management policy is in place to ensure that capital remains sufficient.

We have seen large financial institutions fail (Barings Bank & Long Term Capital Management) or almost fail (Societe Generale) due to “rogue traders” or position sizing issues. These billion dollar institutions had large and robust risk management / compliance departments on hand and still failed to stop multi billion dollar trading losses.

The individual trader has no such department, if you choose to ignore your risk management rules no one will stop you. Thus the discipline to adhere to your rules will be the determining factor in your success or failure.

Our Risk Management Policy is as follows:

1) Trading capital on hand must equal to two times the minimum overnight margin required per contract traded.
2) The per trade stop loss percentage is set at maximum of 0.60% on each trade and is based on a percentage of the total trading capital
3) Weekly stop loss is set at a maximum 6.00% of total trading capital. If this threshold is hit in a Monday – Friday period trading for that week stops.
4) Monthly stop loss is set at a maximum of 10.00%. If this threshold is hit in a calendar month trading for that month stops.
5) If any of the trade plan’s rules are not adhered to, trading for that day stops.
6) Sim trading the plan can continue if a stop limit has been hit.

These are rules that we use, if you use similar rules your percentages could be quite different. The key is to have some idea of when to stop, before your broker stops you.

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