... or any stock, commodity or currency for that matter.
Risk management is crucial. It is the difference between growing and blowing an account and how quickly.
There is the 90/90/90 saying; that 90% of traders lose 90% of their money in 90 days, possibly quicker. Broker stats released here in the U.K., where I am from, confirm that, and I think it would also be a pretty accurate global representation.
But before we can even consider risk management, which is one of the final pieces of the investing puzzle, you must have the ability to pick high-probability stocks.
Trading With An Edge: Impeccable risk management skills will never substitute for poor stocks, so unless you adopt an analysis process that identifies stocks displaying a proven edge, your portfolio will always struggle to gain traction.
An edge is where you have more chance of making a profit than a loss. There is a saying that if you cannot define your edge, you don't have one. And if you don't have an edge, you will get eaten by someone who does. Remember, as we are playing on probabilities, never certainties, even an edge can fail, and this is where risk and exit management come into play.
It is repeatedly acting on a proven edge where where profit far outstrips the losses and how accounts are grown.
Analyzing Tesla Shares: So the first question you have to ask yourself: is Tesla Inc TSLA ready to invest in right now or even the right stock to invest in at all?
That is the foundation. If you struggle to define an edge, I break mine down in detail in this article.
So let's say you have a solid skill set of identifying assets displaying an edge but are not very good at translating that into profit; well, you are an analyst and not an investor. People don't often like to hear this, but those are the facts. It is a choice to put ego over profits which won't help with your end goal, wealth creation.
This suggests that you can filter for good stocks, an analyst skill set, but have not quite mastered the investor skill set of extracting profit. The good news is this can be learned, and the best techniques are indeed simple to learn. The challenge is finding the correct information suitable for busy everyday people and then consistently executing it daily.
Investor skills include understanding how to:
- Calculate optimal entry points
- Place stop losses to not cut out too early
- Manage risk to protect your capital
- Compound to accelerate profit
- Trail price for exiting at the end of the trend
- Apply patience for maximum gains
These rules should all be laid out in your trading plan to remove subjectivity and emotions. The more mechanical you make the process, the better your result. You will also let the price and history of the asset guide you as opposed to your beliefs and opinions.
So what are these three simple risk management rules?
I break them down as follows:
- Max risk per position: Typically 1% to 2% depending on market conditions
- Max risk per day: Typically 4% to 8%
- Max risk allocation: Typically 10% to 20%
Which end of the above ranges I choose is dependent on market conditions. If the indices have no direction as they currently do, but my scanners are picking out stocks outperforming the indices such as McKesson Corporation MCK, which I shared in this recent article, I will err on the side of caution. If the markets are in full bloom, I will go all in.
These rules have served me very well since 2007, when I started investing. They allow me to focus on capital protection, the hallmark of a good investor, and by acting on a proven edge, the profit comes to me.
Good investing is simple but not easy. Learning from my early mistakes and experiences, and putting in the time to adopt what really works, particularly staying true to the principles of investing long term, means being exponentially rewarded. Compound growth is magic that few experience.
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