One of the most important things in trading, if you ask me, is the ability to defend capital. Look, we are all in this trading game so that we can make some loot, that much I think we can all admit by now. We can’t make any loot though, if we have blown all our working capital. Therefore, our defensive game needs to be on point.
To state the last few sentences a little more formally: we need to be able to defend the capital base with which we are working to remain active participants in the market. We only stand a chance of making consistent profits from the market, if we are in fact consistently participating in it. Therefore, making sure that we do not take large losses or find ourselves in a situation where much of our capital is tied up in a particular trade, is rather important.
Ideally, we need to keep liquid capital available in order to take advantage of the trading opportunities that present themselves. Sure, ideals are cool, but perhaps most importantly, we need to not lose too much money in one particular drawdown as it may hamper our ability to make it back. In other words, keep the losses and the trades small.
How do I keep my losses small?
Well, very simply, by making sure that whenever you enter a trade, you enter it based on a high-probability trade setup. This will mean that the trade will have a risk-reward ratio of at least 1:2 (ideally 1:3 or higher). You will be entering the trade off or near a major level or trigger so that you will know very quickly if you have got the trade wrong.
Why keep my trades small?
I like to work on a percentage exposure basis in order to determine my position size. Most people work on a 2% stop loss rule, which is fine, until you have, I don’t know, say 10 trades open all at the same time. Suddenly the general market moves 5% against you and because all the setups were pointing in the same direction, you now have to stop out of all of your trades… 2% x 10 trades… ouch. So for me that doesn’t work.
You have got to keep your trades small enough to hardly matter if it hits your stop loss. And small enough to not really make you think about how fancy that car is going to be that you are going to buy with the profits from this one trade. You get the point? Small and consistent wins. That is how you build a monster trading account. One tiny trade at a time.
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