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Trading for a Living

Risk Management

Trading is very exciting and is the reason why an amateur feels high while trading. Each trade that is done by us should be handled like a surgery, i.e., seriously and without any sloppiness or shortcuts.


A person who is losing his money cannot cut his losses quickly because losing traders keep clinging on hope. Their trading is based on emotions.


Emotional trading is a guaranteed way of suffering losses.


The author recommends developing a simple and good trading system. The more complex the trading systems, the more it is likely to fail. After developing a good system, we shouldn't mess with it.


Mr Elder then gives an example of a person called "Johnny" and states him as an emotional trader. Johnny buys a bad stock and is unable to minimize his losses because he keeps hoping for a reversal.


Successful traders cannot afford to dream in the markets. Dreaming and trading do not go together. A person should do a thorough analysis before investing any money in the markets. this will reduce their risk of suffering losses.


Knowing the basic differences between probability and randomness can help when trading.


There is a mathematical concept explained by Mr Elder which is known as the Player's Edge or the House Advantage. This concept states that for example, when we toss a coin, the 2 persons involved do not have an edge on each other. Each one has a 50% chance of winning. But, when you pull the slot machine in a casino that makes sure that we will lose 10% from every pot, there is a guarantee that we will lose 10 cents for every dollar we bet. This system of house advantage creates a negative expectation for us and a person is guaranteed to lose.


Good management of our money can help us make money and minimize our losses.


The 1st goal of money management is to ensure that a trader survives in the market. The best way to achieve this is to not put your money in a very risky stock. The 2nd goal should be to earn a stable rate of return, and, the 3rd goal should be to earn a high rate of return. The latter 2 goals should be concentrated on only after the first goal is achieved.


Taking big risks and hoping to get rich quickly is a very bad idea. There is a very high chance that you will lose your money. Safer stocks may take time to go up in value, but the advantage of a value stock is that their price does not go down very often.


If you want to be a successful money manager, establishing a good track record is very important.


For example, if a money manager can make 30% profit annually, people will rush to him to manage their money. If you can manage 10 million annually, the management fee can be up to 6%, making 600,000 dollars a year and an additional 30% profits.


The point is that to establish a good track record, a trader needs steady gains and small drawdowns and not the opposite.


A test has shown that a trader can lose a maximum of 2% on a single trade and not damage his/her long-term prospects. This is known as the 2% rule and is very advantageous according to the author. 


We should concentrate on buying quality stocks to trade, rather than making money. The author gives an example of a professional and explains a good teacher will not count their money while they are teaching, rather they count the number of hours they have put in for that day. Similarly, if a trader keeps counting money instead of finding quality traders the chances are that they are likely to lose their money.


Some traders try to establish profit targets, i.e., sell when the price hits resistance and vice-versa. The Elliott Wave theory is one of the best methods to forecast reversal points. This theory is written by R.N. Elliot, which states that every movement in a market can be broken into waves and sub-waves. These are not entirely reliable but can occasionally be used to make correct predictions.


A trader should learn when to place market orders to be a successful trader.


Some have been described by the author:




Near the end of this book, the author says, "a trade does not end when you close out of position". Instead, we must analyse it and learn from it. Learning from our past experiences is the only way a person can evolve into a good trader.

The second point which the author states is to keep a before and after notebook, to analyse the reasons of why you decided to get into a trade. Is it simply because it looked good, or a proper analysis was done? Same rules apply for exiting. 

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Units 17/17