Defining Risk in Your Trading

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Defining Risk in Your Trading

Do you know exactly how much you risk each time you place a trade?

In his recent article ‘The Commitment Secret’, Dr. Kenneth Reid challenged us to commit to an ongoing process of self-improvement. In today’s article, we want to consider the topic of trade risk.

Do you clearly define the point at which you will exit a trade if it goes against you?

If we trade without pre-defined exit points, our risk is infinite. As such, it is impossible to calculate the financial risk of that trade, and exposes our entire account to risk. Not only is this extremely bad for our pocket,  but it’s also a source of a immense emotional pain and psychological damage.

In this scenario, where would we exit the trade, and by then how big will that loss be?

Do you clearly define how much of your account you will risk on each trade?

If I enter a trade with the same lot size for each currency pair, then I am not defining my risk. Why? Because each currency pair has a different cost per pip. For example, one standard lot on the EURGBP is around $12.80 per pip, whereas one standard lot on the GBPAUD is around $7.50 per pip. So the risk on the two trades is not the same with an equal lot size.

Why should we define the risk on each trade?

If we consider how we bet on a horse race then the answer is quite simple.

The odds are calculated on the probability of a horse winning and we use those odds to define our trade parameters. So, for example, if the odds are 10:1 and I bet $1, then a win would return my $1 stake and $10 in profit. However, if my horse does not win then the bookie keeps my $1 bet. In this scenario, I fully understand that I will lose $1 if my horse does not win and I have considered it a worthwhile trade as I have the chance to make $10 by risking $1.

Now, if the bookie couldn’t tell me how much I will lose if the horse fails to win, but that it might be all the money in my account, (which, incidentally, he holds for me in his own bank account) would I then take a bet on that horse? I certainly wouldn’t – but yet, surprisingly, many traders do.

What are the benefits of defining and accepting the risks on each trade?

How about I say you can be the bookie (to define the trade odds) and then also the customer to take that trade? Well, that is just what we do when we trade.
So, for example, I could set a stop loss at -50 Pips and take profit at +100 pips (1:2 risk to reward) and then risk $100 on the trade. If the trade stops out I lose $100 but if the trade is a winner I will gain $200.

But just remember, as the bookie or as the customer, I have no way to determine or influence the outcome of the race, I am just defining my trade parameters and must accept the outcome.

The skill in trading is then to find high probability trades and to pre-determine the exit, which is the subject for another day.

How do we determine the risk in Hawkeye Tomahawke FX?

Hawkeye Tomahawke Chart

Using the Tomahawke method, we use a trade execution tool to place our trades quickly, as we are trading the shorter time charts.

This tool makes us place a stop in the charts. We think about and determine the point to exit that trade should it go against us. In the settings, we also pre-determine how much of our account we wish to risk on each trade (normally  ½ percent on each trade).

When we take a trade, the software automatically calculates the lot size given the number of pips to the stop and the total value we are risking on that trade. So, for example, if we are risking $100 on a trade with a 10 pip stop, then we risk  $10 per pip. The software calculates that as a lot size and enters the trade. Should the stop be hit, we will lose $100 and no more. We accept this as our defined risk.

I hope this article helps you to think about risk in your trades and how to become a better trader.

 


 

Join Me in the next free LIVE Hawkeye Demonstration Room held every Wednesday at 9.30am EST US. You will learn more about volume and volume price analysis and see more examples and live trade setups. It is open to all.

Click this link for more information or to join us in class.

Learn to trade the Hawkeye way.

Good trading,

Randy Lindsey
Hawkeye Traders, LLC

Market Update and Insights

by Guest Columnist, Max Larsen, Future Finances, Inc.

This week we welcome Max Larsen, President of Future Finances Inc. to the blog as a guest columnist for a review of the week’s economic news. Max is a professional money manager, with $200 million under management and a long time user of Hawkeye.

1. Weekly Wrap
2. Technically Speaking
3. Business Optimism Goes Stratospheric
4. Inflation is Creeping In
5. Johnny Depp – A Lesson on What Not to Do

Weekly Wrap

The past week was rife with earnings, economic data and commentary from two major central banks, but the market shrugged off the busy event calendar remaining in its range bound ways.

The big news of the week was a decent jobs report with employers adding 227,000 jobs last month according to the Labor Department. This was the biggest gain since September although wage increases were rather modest. This from The Wall Street Journal (weekly summary from Briefing.com):

The backdrop of a steady but unspectacular labor market is likely to keep the Fed cautious about raising interest rates and could prevent the central bank from colliding with President Donald Trump as he aims for faster economic growth.

Indices Weekly Figures

We shouldn’t forget about earnings season. Our very own Brad Huffman chimed in:

In addition to a slew of economic reports, earnings season continued to unfold. These were generally supportive of the current trend. The most significant weakness has come from large multinational companies indicating concerns about overseas activity. Despite those concerns, both earnings and sales growth are poised to expand for the quarter.

Please remember that historically speaking February is one of the weakest return months of the year with the worst part coming towards the end. It may not happen this year. There is a lot of money flowing into stocks right now.

Technically Speaking

I have two charts to share today. The first is from Arthur Hill of StockCharts. He points out that it has now been 79 days since we’ve seen greater than a 1% decline in the S&P 500. Talk about “range bound”…

Just look at the bottom indicator called the ROC or rate-of-change. This is nothing more than how much the S&P 500 changed on a percentage basis on a daily basis. I high-lited the 79 days in blue. It denotes a strong market to me.

S&P 500 Chart

The second chart is one you’re very familiar with. This is the 8-months chart of the S&P 500 (daily prices). Notice how we came into the “Support” zone last week and bounced out on Friday.

S&P 500 Chart

I still contend that we are due for a pullback. It may not happen, but I could envision a minor correction to the “Critical Support” area (red high-lite) which would only be less than a 5% retracement and still well within the upward trend line and above the 200 day moving average. We’ll see…

Business Optimism Goes Stratospheric

We have gotten numerous emails and phone calls on people’s concern for the stock market’s lofty state. Once again here’s Brad Huffman on a nice reply that I had to share:

Thanks for the note. The market is responding to views that tax and regulatory changes from the new administration will help improve economic conditions. We do believe in the short term we will see a slight pullback (maybe 5%), but that would be normal and draw in new investors. The technical and fundamental pictures are pretty healthy right now, but volatility will remain present as it did last year.

We have several positions in the portfolio that help us hedge any market swings so unless we see significant deterioration in the charts, we are comfortable with the moderate risk exposure we have in the portfolio.

Brad is correct. Just take a look at the most recent NFIB Small Business Index.

NFIB Small Business Index Chart

Like its title says – it measures the business optimism on a quarterly basis. This stratospheric 38-point jump in the number of business owners who expect better business conditions is staggering.

Whether you like the President or not – and I know there are many who don’t – it is what it is and we have to live with it. That said, there is little doubt the WSJ’s headline hits it on the head: “Trump Pace Has Heads Spinning.” Many businesses are very encouraged that someone is finally attacking the mind-numbing regulations and restrictions.

Inflation is Creeping In

Consumer Price Index YTD ChartWe’re starting to see the possible resurrection of a little inflation. The Eurozone just reported a 1.8% rise in consumer prices while we’re hitting 2.1% in the U.S. The Wall Street Journal chimed in:

After years of fighting against deflation, the U.S., the eurozone and Japan show glimmerings of life in consumer prices and wages, evidence that an era of exceptionally low inflation is receding from the global economic landscape.

Several factors are behind the move, including a rebound in energy prices, falling unemployment which is reducing slack in some labor markets, and central banks’ low-interest-rate policies that spur lending and economic growth.

To be sure, any economic shocks could reverse this trend. Still, this is important since certain asset classes – like commodities and gold – tend to thrive in this environment. However, those sectors which are bond proxies – like telecom services and utilities – tend to do badly when inflation and interest rates rise. Be forewarned…

Johnny Depp – A Lesson on What Not to Do
Johnny Depp

Johnny Depp is having money problems and is suing his business managers for mishandling his finances. It turns out that it may not be all their fault and are counter-suing since the Pirate of the Caribbean star was spending more than $2 million a MONTH to maintain his lifestyle. In spite of repeated warnings he is now having serious money problems. This from CNBC.com:

The lawsuit said Depp paid more than $75 million to buy and maintain 14 homes, including a French chateau and a chain of islands in the Bahamas.

Depp also spent heavily to buy a 150-foot yacht, fly on private jets and cultivate collections of fine art and Hollywood memorabilia requiring 12 storage facilities to maintain, the lawsuit said.

$2 million per month and $75 million in non-income producing assets? What could possibly go wrong? He’s obviously a very talented actor yet it boggles the mind that he could be so inept with his finances – whether he had an advisor or not… You can read the entire article HERE.

That’s more than enough for this week my friends. Congratulations to the New England Patriots. Wow, what a game. Multiple records broken – including the biggest comeback in Super Bowl history. It just goes to show you – never give up. Have a fantastic week!


Join us in the next free LIVE Hawkeye Demonstration Room held every Wednesday at 9.30am EST US. You will learn more about volume and volume price analysis and see more examples and live trade setups. It is open to all.

Click this link for more information or to join us in class.

Learn to trade the Hawkeye way.

Good trading,

Randy Lindsey
Hawkeye Traders, LLC

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