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Money management or risk control strategies are the most critical requirement for a successful trader. Without exception, every outstanding trader will tell you that it is the most important factor that determines your success. All traders starting out make many mistakes, and are constantly making learning distinctions. As these traders obtain good judgment, they will make many new learning distinctions. Unfortunately, most new learning distinctions result in a loss of equity. Traders who have risk control strategies will be able to survive these errors. Without risk control parameters, the likelihood of losing a large percentage of trading capital will be overwhelming. The preservation of capital is a primary consideration. It is the underlying concept of all money management strategies. |
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While I was working for Lind-Waldock, one of the differences that was very obvious between novice and professional traders (besides their belief structure) was how the professional trader followed very strict risk control procedures, and the amateur trader had none. Risk management strategies have a huge impact on the amount of profit generated. Other, lesser factors that affect the amount of profit generated include the amount of money in the account, the trading methodology, and the experience of the trader. This is the longest chapter of the book. Without the ability to preserve your capital, you will exhaust your trading capital before you have developed your beliefs or methodology. |
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Importance of Risk Control |
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The primary reason risk control strategies are more important than trading methodology is that the trading strategy, regardless of how well it has been researched and back-tested and regardless of its profitability, could lose money. Every time a trader enters into a new trade the risk is always guaranteed. Whether that new trade generates a profit or a loss depends on variables unique to that trade. Traders want to manage their equity so it is steadily increasing. The equity curve, if plotted, should show a steadily increasing arc with many small high and low points, much like a saw blade that is slanting upward. It should not show huge up and down equity swings. Should the deviation or the swings be too great, the trader will eventually lose all capital. Figure 18-1 summarizes the curves. |
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