Today in our Beyond FOSO column, we are continuing our look at Tradesmart University classes that you can take after completing the Foundations of Stocks and Options course. These classes are designed to provide you more advanced training in various trading arenas. We originally covered Chris Burgess’s class Beat the Market, which you can read here. In Chris’s class, he taught us how to find the best companies and stocks to trade. Thus, our next logical step in learning will cover how to limit your risk when trading your selected stocks so you can hold on to the profit you have gained. We can find this topic covered in Alphonso Esposito’s class Risky Business.
The core idea behind the Risky Business class is learning to manage and measure the risk on your trades by incorporating Risk Units or R’s into your trading plan. A Risk Unit is defined as:
The amount a trader is willing to lose on a trade if it hits his or her stop.
After all, stops are your friend and not your enemy because they allow traders to limit their losses and preserve their trading capital. You will determine the stop price before you enter the trade, and as soon as you place the trade, you will place your stop based on how much money you are willing to risk on the trade. Remember to always use a hard stop on every trade until your target is reached, and then a trailing stop is acceptable. When determining your stop price, it is usually the point on the candlestick chart where the probability of the trade working as initially planned does not exist anymore, and the pattern is broken.
Thus, your stop price keeps you from losing more than your predetermined R amount on a losing trade, and your R allows you to know upfront your maximum potential loss for each trade. When trading, you should be ready to completely accept the possibility of the maximum loss of your R amount. If that loss amount is not acceptable or too painful, then you must lower your R to an amount you are willing to lose.
It should be noted; your “R” must always be the same amount for each trade taken over a predetermined amount of trading days or trades. Picking different R’s for each trade will never lead a trader to consistent long-term profitability, as you should let your analysis play out on each trade with the same amount of risk. After all, your predetermined acceptable Risk Unit removes all emotion from your trade, as you are equally prepared if the trade turns against you as you are if the trade becomes profitable.
The main benefit of R trading is it keeps your losses limited to a set amount. When you define the amount of money you are willing to lose on any given trade, you instantly know your potential loss. Which in turn, removes any emotional attachment to your money as you have already figured out how much you are willing to put at stake. Plus, when you keep your R amount the same, it keeps a level of consistency across all your trades and helps to increase your size profits in a controlled manner over a set period of time.
The R system is a systemized plan that allows a trader to focus on acquiring skill and developing consistency in your trading. It will help you remove the emotion of dollar counting or trading for money. Finally, it is an individualized and unique risk management system that grows your account without big setbacks. Around Tradesmart University, we firmly believe, if you start using this system today, it will save you from massive losses tomorrow.