RISK

Institutional, retail, trend, swing, technical or fundamental

regardless of what type of trader is at the other end of the mouse,
we all must take calculated risks to make money in the market.
MANAGE
FOR TRADI NG LONGEVI T Y
B
y

T
o
m

B
u
s
b
y
Some risks pay off in
rewards, and others are
realized through losses.
Having been deeply
involved in the finan-
cial markets for nearly
30 years, I have had the
opportunity of seeing
just about every method,
system and trading tool
out there. From the CEO
of a major Wall Street
firm to the individual
trader managing his
own money, success
boils down to how you
manage risk.
Without an under-
standing of the risks in
the market, traders are
unprepared for the unex-
pected. What to ask be-
fore placing a trade:
WhereamIvrong?
IovmuchamIrIskIng
loreachmylargel?
WhallypesoIadjusl-
ments can I make if a
gamechangeroccurs?
KEEP EGO OUT OF IT
Repeat after me I am
not the smartest person
in the world. Say that
again three times, and
you will be on your way
to becoming a better
trader already. As soon
as ego gets in the way
of a trade, the blinders
go up, and the account
balance goes down. It is
important to believe in a
trade and have convic-
tion, but not to the point
of no return.
I have learned to rec-
ognize where and when I
am wrong.
WHERE ARE
YOU WRONG?
By understanding that
you are not the smartest
person in the world, you
will be able to see when
a great trade setup might
actually be a bad trade
setup. It may be a great
trade setup, but news or
some other unknown fac-
tor can cause that trade
to go against you. Before
any trade is taken, I al-
ways want to know where
I am wrong on the trade
(meaning where I will exit
and take a loss).
THE CHARTS CAN HELP
Two technical things
that I focus on, regard-
less of what markets I am
trading, are support and
resistance areas in the
instrument I am trad-
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There is a substantial risk of loss in trading commodity futures, options and off-exchange foreign
currency products. Past performance is not indicative of future results.
instrument I am trading.
See Figure 1.
BE SYSTEMATIC
Once those numbers are
plotted, I begin to build
a key number ladder and
look at where the instru-
ment is trading in rela-
tion to those areas. Then
I begin to look for recent
highs, lows or areas of
major support based on
a 30-minute chart (these
are known as market
generated key numbers).
I then compare the num-
bers from the 30-minute
chart to my historical key
numbers and set a stop-
loss order.
If I am long when
the market takes out
those support areas and
gets below the daily or
weekly open, I know I
am in trouble. Regard-
less of what method
you use for support and
resistance, always have
a point on the trade
where you pitch a trade
and take a loss. Stop-
loss orders are extreme-
S
o
u
r
c
e
s
:

D
T
I

R
o
a
d
M
a
p

FIGURE 1: Year Open as Key Pivot
1077.00
1086.00
1095.00
1104.00
1113.00
1122.00
1131.00
1140.00
1149.00
1158.00
1167.00
1176.00
1185.00
1194.00
1203.00
1214.00
1221.00
1230.00
1239.00
1248.00
1257.00
1266.00
1275.00
1284.00
1293.00
1302.00
1311.00
1320.00
1329.00
1338.00
1347.00
1356.00
1365.00
01-21-2011 03-18-2011 05-13-2011 07-08-2011
Key Pivot Area of Yearly Open
Note how the yearly open has proved to be an extremely important pivot (key number). If the E-mini S&P futures are below this area, I will manage
risk by being very cautious on any long stock or options trades.
ing, as well as the overall
market direction.
Support and resistance
can be determined by ex-
amining pivot points, Fi-
bonacci levels, previous
highs and lows and by
drawing just about any
kind of line on a chart.
When I nd support and
resistance, I keep it sim-
ple. I look at important
openings in the market
(these are known as
historical key numbers):
yearly, monthly, weekly
and daily opens of the
ly important to limit the
amount of loss.
DONT MAKE
THIS MISTAKE
Many traders risk a lot to
make a little. A trade is
taken with $500 worth of
risk to make $100. There
are some option strate-
gies (credit trades) where
a maximum risk might
be 4:1 or 5:1, but it is im-
portant to manage those
trades so that a full loss
is not achieved.
On more traditional
trade strategies, I typi-
cally recommend a risk/
reward of at least 1:1
(meaning if $1 is risked,
then the target should
be at least $1). If you log
your last 10 trades, take
a look at average gain
versus average loss. Cal-
culate what percentage is
needed to break even.
I would argue that most
traders losing money
will have losses that are
two to three times their
amount of gains. When
setting up a trade:
Inovvhereyouare
wrong
Inovvhereyouare
right
MakesurelherIsk/re-
ward ratio ts in with
your accuracy rate
BE PREPARED
Anticipate game chang-
ers. Never take a trade
that has so much size that
you are essentially all in.
If you go all in with the
markets, eventually some-
one else will end up with
your chips.
Consider economic
events that would affect
your position and how
you would manage risk.
What happens if the mar-
ket gaps down? What will
that do to your stop, and
how will you react? How
can you hedge a position
if the exchange you are
trading on shuts down for
one reason or another?
PROTECT YOURSELF
To protect against game
changers:
InderslandlheoplIons
market and different
strategies that can be
taken to hedge or pro-
tect a position
IaveanrmgraspoI
how to access the 24-
hour futures market
There is a saying in
trading: There are old
traders and bold traders,
but there are no old, bold
traders. The key is not to
hit the Lotto, but to con-
sistently take advantage
of setups when the odds
are in your favor.
Wait for the best op-
portunities, measure the
risk and then reap the
rewards.
Tom Busby is the founder and
CEO of the Diversied Trading
Institute (DTI).
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