​Accepting and Reducing Risk

Trading is risky. Depending on your personality, you may be extremely intolerant of risk. I know a man who uses "riskaverse" for his email address.

Most people avoid risks at all costs. Humans had to make prudent decisions in order to survive and evolve. Even though traders know they must risk money to make money, the natural inclination to avoid risk is powerful. How much risk are you willing to take? There's no right answer. It depends on you. If you are a risk seeker, you may not mind risk. You may actually embrace risk and uncertainty. But if you're like most people, the more risk you can eliminate, the better.

You used to be able to avoid risk entirely by putting your money into a savings account. However, those days are long gone, and such an investment would bring relatively little profit.

The lure of short-term trading is that you have the potential to make huge profits. The downside is the uncertainty and risk you must accept.

However, the amount of risk you take is still up to you. For example, for most, but not all traders, it is more risky to trade markets with excess volatility or very little liquidity, so avoiding them will help you stay calm if you have low risk tolerance.

Traditional approaches to risk control can also help, such as having a diverse portfolio. If you trade various markets that have little correlation, you have some insurance that a drop in one market may not automatically coincide with a drop in other markets. But no matter how much you try to avoid it, you must decide how much risk you are willing to take.

Perhaps the most unnerving aspect of risk in the markets is the fact that it is impossible to know all possible risks up front. Who knows what will happen?

There are many events that you just can't control. For example, a media analyst may talk up or talk down a market you're trading, and it may thwart your trading plan. An unexpected national event may influence the markets in ways that you hadn't anticipated. And when it comes to selling off a position, you might not get the price you want at the moment you're trying to sell. And then there are more basic problems that hamper your plans, like a computer crash or an Internet connection line going down. In the end, you must psychologically accept the fact that there are some risks that you can't control.

You may not be able to completely avoid all possible risks, but you can take steps to reduce risk. For example, by setting a stop loss you can, within limits, determine how much loss you are willing to take. It may take some skill to know where to place the stop loss so you won't get prematurely "stopped out," but in principle you can reduce your risk by deciding a point at which a loss is great enough that you would rather close the trade than continue.

You can also reduce risk by avoiding thinly traded markets. Even the most brilliant trading plan will fail if there aren't enough buyers and sellers to make it work.

Reducing risk can be a matter of choosing the right stock market: if you are especially risk-averse, you can stand aside until there is a strong bull market. But whatever you decide to do, always remember that you have choices. You can decide how much risk you want to take. By matching the amount of risk you take with your tolerance for risk, you can trade more calmly, and that usually means you'll trade more profitably.

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