Consider Risk First, Then Reward

Anytime I am eyeing a trade to make, the first thing I consider is what is my risk in case I’m stopped out. Theoretically I might not be able to foresee all that could happen to a stock, but barring a major news event or gap in the stock, I want to first determine at which point I’ll need to exit the position. Only after this step do I take a look at the positive potential for the trade and then move towards a decision for an entry.

A major difference between amateur traders and professionals is the fact that amateurs consider the potential reward first and then may look at their risk, while professionals consider their risk first and then look at the potential reward. This is a big deal!

Keep Your Head On Straight

The market carries a lot of allure and it can entice you into making larger or bolder trades when all you look at is the reward side if it pans out. However, surviving the trading game and sticking around long enough to make a living at it will require that your risk be quantified before anything else. Even with those home-run types of plays you might feel very strongly about, you still need to determine at which point you’ll bail out of the trade and cut your loss in the event that you’re wrong.

Consider the earnings play by the amateur trader trying to make a quick, easy buck on a favorable gap from the announcement. This play is attempted all the time, but the truth of the matter is that while the odds are high that a gap will come, the direction and size of it simply cannot be determined. This leaves the trader hoping to hit it big but very uncertain as to their exit plan if the stock moves against them.

Trading Like A Pro

Professional traders operate in a completely different manner. What appears to be a good trading opportunity is examined before the entry is made. This closer look may not take a long time, but it will reveal to the professional key information that will make up his mind on whether or not to take the trade. Determining an adverse exit level will allow him to define his risk, size his position accordingly, and then decide if a favorable move will pay him a multiple amount of what he’s putting at risk.

This principle is at the heart of profitable trading, because we are going to have our losing trades, sometimes frequently. Ensuring that those losses are contained will make them very easy to overcome with winners that we will find, but a methodical approach which begins with a look at the risk is where it all begins.

Jeff White
President, The Stock Bandit, Inc.
Swing Trading & Day Trading Service
www.TheStockBandit.com

[tags]Stock Market, Day Trading, Stock Trading, Investing, Swing Trading[/tags]