Investors and Traders Must Know This...Risk And Money Management

In an age where it has become fashionable to manage one's own investments, every investor needs to apply professional risk and money management strategies.

Preservation of capital is the foundation of long-term success in today's volatile markets.

One common adage on this subject that is completely wrongheaded is:
"You can't go broke taking profits." That's precisely how many traders do go broke. While amateurs go broke by taking large losses, professionals go broke by taking small profits. The problem in a nutshell is that human nature does not operate to maximize gain but rather to maximize the chance of a gain.

The desire to maximize the number of winning trades (or minimize the number of losing trades) works against the trader. The success rate of trades is the least important performance statistic and may even be inversely related to
performance.

The market does behave very much like a tutor who is trying to instill poor trading techniques. Most people learn this lesson only too well...

Since most small to moderate profits tend to vanish, the market teaches you to cash them in before they get away.

Since the market spends more time in consolidations than in trends, it teaches you to buy dips and sell rallies.

Since the market trades through the same prices again and again and seems, if only you wait long enough, to return to prices it has visited before, it teaches you to hold on to bad trades.

The market likes to lull you into the false security of high success rate techniques, which often lose disastrously in the long run.

The general idea is that what works most of the time is nearly the opposite of what works in the long run.

When asked about risk and money management, we often hear the same two phrases from investors: "I'm diversified" or "I have a balanced portfolio".

But are they really?

And does this have anything to do with risk and money management?

We all know the oldest clichés in the world of investing:
"Buy low, Sell high and Make Money."
"Cut Losses Short, Let Profits Run."

This is easier said than done.

Some investors devote countless hours to stock
picking by spending their time doing research, using either fundamental or
technical analysis. Others visit chat rooms, message boards or get tips from
neighbors. Many approach investing as if it were a gamble, without knowing the risk reward equation. In the never-ending quest to find the next momentum stock to buy, the most important factor in long-term profitability is overlooked - the exit strategy.

Managing one's risk and capital is undoubtedly the two most important, yet among novices the most ignored, tasks in establishing long term trading success.

Sharing some quotes from the top traders to further emphasize the importance of risk and money management:

"You should always have a worst case point. The only choice should be to get out quicker." - Richard Dennis

"If I have positions going against me, I get right out; if they are going for me, I
keep them... Risk control is the most important thing in trading. If you have a
losing position that is making you uncomfortable, the solution is very simple: Get out, because you can always get back in." - Paul Tudor Jones

"The elements of good trading are: (1) cutting losses, (2) cutting losses, and (3)
cutting losses. If you can follow these three rules, you may have a chance." - Ed
Seykota

"Throughout my financial career, I have continually witnessed examples of other people that I have known being ruined by a failure to respect risk. If you don't take a hard look at risk, it will take you." - Larry Hite

"Frankly, I don't see markets; I see risks, rewards, and money." - Larry Hite

"My philosophy is that all stocks are bad. There are no good stocks unless they go up in price. If they go down instead, you have to cut your losses fast... Letting losses run is the most serious mistake made by most investors." - William O'Neil

"When I became a winner, I said, 'I figured it out, but if I'm wrong, I'm getting the hell out, because I want to save my money and go on to the next trade.'" - Marty Schwartz

"I always define my risk, and I don't have to worry about it." - Tony Saliba

"When I get hurt in the market, I get the hell out. It doesn't matter at all where the market is trading. I just get out, because I believe that once you're hurt in the market, your decisions are going to be far less objective than they are when you're doing well... If you stick around when the market is severely against you, sooner or later they are going to carry you out." - Randy McKay

"The key to trading success is emotional discipline. If intelligence were the key,
there would be a lot more people making money trading... I know this will sound like a cliché, but the single most important reason that people lose money in the financial markets is that they don't cut their losses short." - Victor Sperandeo

"Never fear making a mistake. If you do make a mistake, don't complicate the
position by trying to hedge it - just get out." - Linda Bradford Raschke