How your perception of risk can sabotage your trading
Dear Traders,
Most market players recognise the importance of risk management.
However, this doesn't prevent us from failing to correctly implement a trading risk plan.
Did you ever wonder why controlling the risk in trading can be so challenging?
This article will teach you how to defend yourself against risky behaviour and fearful trading.
Moreover, I will show you how your trading behaviour makes you vulnerable.
Trader's risk perception fluctuates
The reality is that people behave differently, depending on whether they experience loss or profit:
...a trader who keeps losing will risk more…
...and a trader who keeps winning will risk less.
Our emotional reaction to winning and losing, decides whether we go for a more conservative or aggressive approach in trading.
The problem with fluctuating risk perception
The biggest problem is that good intentions regarding trading risk management, can quickly become obsolete.
Even if traders know how important a risk management plan is:
...the dynamics change once real trading kicks off.
A few losing trades may make you think further risk is acceptable, while winning trades may cause you to act overly cautious.
To learn more about proper risk management plans, check out our video below.
Your trading risk profile
Reaction to risk is not the same for all traders, because people's risk profiles vary.
In fact, there is a wide range of risk attitudes.
Some traders are born risk takers, while other are very conservative.
Your risk attitude affects how and when you react during periods of loss or profit.
Traders with:
- higher trading risk tolerance, tend to risk more when losing - but not necessarily lose risk appetite when making profits
- lower trading risk tolerance, tend to lose risk appetite when making profits - but not necessarily risk more when losing.
How to battle your risk weakness
The first thing you need to do is adopt the right trading risk attitude.
Be honest with yourself and analyse what type of risk attitude you have.
See the table below to check when you are vulnerable to being too cautious or too risky.
Once you know your risk attitude, you can start improving your overall trading risk implementation.
Let me give you two examples:
- if you are a risk taker, you need someone else to manage your risk for you
- if you are too cautious, walking away from the computer could help remove the temptation to take profits too soon.
Ultimately, it's important to understand:
...when and why we make mistakes in trading...
...the need for a tailored risk analysis and to work on improving risk management.
Hopefully this article has helped you increase your risk awareness and start making steps towards improving your trading.
Cheers and safe trading,
Chris
