Risk Size Is Key 09 September 2012 - 10:46 am YOUR WINNERS CAN RUN .

IF YOU LET THEM The proponents of risk/reward ratios say that in order to be successful the trad e must out produce the amount of money you have at risk by at least double or tr iple your risk amount but what they fail to take into consideration is that the reward side of any trade is unknown. WHAT YOU CONTROL You see the only part of the trading equation that you have any control over is the risk side of the trade. The reward side of any trade is a complete mystery. Oh sure, we all have our best guesses as to where the market might go next, but in the end it s really just a crap shoot. Sometimes we re right and sometimes we re wr ong and if we re honest with ourselves we will admit that we really don t know where the market is going next. If we don t really know where the market is going, namely the reward side of the t rade, why would we even include it in our trade scenario never mind making it th e deciding factor of whether to take a trade or not? Obvious, right? Yet in spit e of this I continue to encounter traders who insist on only taking high risk/re ward trades thinking that they are being smart investors by doing so. CONTROL YOUR RISK The truth is the risk side of a trade demands much more consideration than the r eward side. Successful traders know this. They know that the market will move mu ch more/less than they ever expect it to and controlling your risk exposure and taking what the market will give you is far more important than basing a trade o n some pie-in-the-sky profit target. DON T MISS OUT How many times have you passed on a poor risk/reward trade only to watch it expl ode and never look back? Or how often have you gotten into a good risk/reward tr ade only to watch the trade fall flat on its face? If you re honest it s probably ma ny more times than you d care to admit. LEARN FROM THE LEGEND Consider this quote from Paul Tudor Jones, one of the most successful traders of recent times: Where you want to be is always in control, never wishing, always trading, and alw ays first and foremost protecting your ass. That s why most people lose money as i ndividual investors or traders because they re not focusing on losing money. They need to focus on the money that they have at risk and how much capital is at ris k in any single investment they have. If everyone spent 90 percent of their time on that, not 90 percent of the time on pie-in-the-sky ideas on how much money t hey re going to make, then they will be incredibly successful investors. THE TAKEAWAY Did you get that? Paul Tudor Jones says that the most important part of any trad e is the risk side of the equation, not the reward side. Jones knows what most t raders don t know, namely that the reward side of a trade is unknown. Jones says t hat the reward side of a trade is pie-in-the-sky and yet that is where most (losin g) traders put their emphasis. FIRST STEPS How does a trader control risk? Risk control is all about proper position sizing . Proper position sizing means that you never risk more of your trading account than you can afford to lose in any single trade. In fact, with proper position s

izing it is possible to turn a profit even if you re trading a 50/50 system! Sound impossible? The math doesn t lie. Proper position sizing means that you never ove rcapitalize a losing trade or undercapitalize a winning trade. For most traders a proper position size means risking less than 2% of their trad ing capital on any single trade, but in general anything less than 5% of your ac count is considered prudent. What is important to realize here is that the risk amount remains the same on every trade. This means that the number of contracts changes, not the size of the stop. Did you get that? Regardless of where you pla ce your stop; whether you have one point or ten points at risk the dollar amount remains the same; but the size of the position changes to keep your 2% risk exp osure constant. LET YOUR PROFITS RUN FREE This should be a very liberating concept for most traders. Knowing that your ris k amount stays constant allows you to place a wider initial stop so as not to st rangle your trade in the beginning when choppiness and a wandering market are mo st likely. Compare this with the old risk/reward mindset which normally demands extremely tight stops in order to maintain a favourable ratio but by doing so yo u are setting yourself up for early failure if the market doesn t immediately move in your direction.Paul Tudor Jones has it right and if you take the time to thi nk about it you ll see that basing a trade on a risk/reward ratio, where the large st part of the equation is a complete unknown, is foolish at best. Yes, Mr. Jones has it right but the bigger question is: are you listening?