The traders who win are those who minimize risk. Those who do not minimize risk inevitably pay the price and get wiped out.
It is for this reason that you often see strong moves after a news item is out of the way, often a news item suggesting a strong move in the opposite direction. The big traders, who got that way by minimizing risk in the first place, wait until the risk is at its lowest, when the news is out of the way.
Risk Control includes the following:
- Not trading in too big a size, thus reducing the risk of a wipe out. Actually you should eliminate the risk of a wipe out.
- Not holding overnight unless you have a profit buffer in place. However this does not apply to particular methodologies seeking to take advantage of certain factors which may apply to holding overnight.
- Not holding over the weekend, subject to the same caveats as “2”above.
- Taking appropriate action prior to major new items. This means not normally opening positions, maybe reducing position size if already positioned – although it does depend on your trading objectives.
But in markets there are two types of risk and we need to look at both.
First there is the risk of loss inherent in the market itself. Second there is the risk of loss inherent in the vehicle we are trading. Simply put, the risk of making a losing trade when buying an option is far higher than when writing an option. But you can lose a lot more writing options, than you can buying them. This neatly demonstrates the two types of risk and, as traders, we need to understand how this works.
The market mechanism drives price from one extreme to the other. Once an extreme is reached price can only go one way.
Good news and bad news represent risk, but the market can provide excellent indications that an extreme may have been seen.
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