SIMPLE WORDS BUT TRADING WISDOM

by Mike Lally

Trading is 80% psychological and 20% technical
You must confront your personal idiosyncrasies
You cannot survive in trading without limiting your risk
The important elements of a risk management strategy are:
Risk-Reward ratio
Diversification philosophy
Position size algorithm
Maximum risk per trade
Stop-loss strategy
Psychology of adjustment after losses
You must limit your losses to survive
You control risk by controlling yourself
You must have a written trading plan
Decision trees are useful to visualise the risk options
You must know the time frame you are trading
You need to consider all risk scenarios

The greater the reward the greater the risk
The greater the risk the greater the opportunity
If you lose 50% of your capital on a single trade you will need to win 100% on your next trade to recover your position
The probability of an outcome is the ratio of favourable outcomes to the total number of possible outcomes
The mathematics of probability is at the very core of the management of risk
Risk management is the study of ruin
Reduce your exposure to equities in a bear market
When making a risk decision your personal feelings play the most significant role
Determine your maximum drawdown based on the performance of your system
Establish a risk-reward ratio
Decision trees, expected value and expected utility are important components of risk theory

There are two forms of risk the trader must consider:
Risk belonging to a company and Market-related risk
Volatility can be measured in many ways; three common methods used are:
Standard Deviation
Average True Range
Bollinger Bands
Volatility plays an important role in trading

You can successfully reduce risk by diversification
Correlation plays an important role in diversification
Trade your plan around your risk management strategy
There must be sufficient liquidity to sell a stock
Aim to produce a gradually increasing equity curve
You must monitor your stocks every day
You should determine the profitability of your portfolio periodically
The even playing field is a trading myth
Martingale systems do not work
Overtrading will damage your account
Do not complicate your trading – resolve to keep it simple!

Your position size reflects your risk to reward expectation
Experiencing multiple successive losses will happen to you
Restrict your trading until you know what you are doing
When things go wrong take a break
Professional trades restrict the risk premium to 1% – 2% of their trading capital
There are many position size algorithms including:
Volatility method
Percentage of capital
Equal amounts
The Fixed Fractional Model reduces the trading capital for each successive trade by the risk amount of the previous trade
The Total Equity Model uses the trader’s full capital potential including profit from open positions and cash in hand

You will not survive without a stop-loss
There are many ways to set a stop including:
nearest support or resistance line
fixed dollar amount
pre-determined percentage amount
trailing stop technique
placing the stop below the pivot low
placing the stop under last week’s lowest price
parabolic stop and reverse (SAR)
You must know in advance the point where your analysis has failed
The setting of stops is not a simple task
There are many types of stops including:
Initial Stop
Mental Stop
Time Stop
Money Management Stop
Breakeven Stop
Trailing Stop
Parabolic Stop
Volatility Stop
You should move your stop to the breakeven point as early as possible
You can adopt different stop-loss strategies for your trades
The 2% rule is recommended for professional andd amateur traders
Consider taking a partial profit as a risk strategy