The market is subject to countless forces beyond our control. Political strife, natural disasters, underwhelming forecasts, all of these things can derail even the most well thought out and carefully planned trading plan. So, without the necessary foresight to predict all of the uncertainty the market will throw at you, how do you prepare for uncertainty?
Even though we’re at the market’s mercy, there are a handful of tools we can use to fight the worst consequences of disaster by building a low risk portfolio.
While some of the tools might sound elementary to more advanced and expert traders, they still need to be emphasized. Time after time, we see a range of experienced traders fail these basic concepts daily.
We have no control over the market – Once you’re in a trade, accept that you have no control over the market’s direction. Whatever you do will not really affect a market.
Leave your ego aside – You’re a small player, and the harsh truth is that your trades will not impact the market. Understanding your small footprint is a key thing when it comes to erasing our egos.
Control your position size – It is imperative that we let mental trading take control over any emotional decisions. The only thing we have control over is the position size. While the market acts against our expectations, we can reduce the exposure and lower the risk. If it goes with us, we can add as the market shows us and so on.
Use catastrophic stop-losses – If the market impulses very strongly against us, we still want an automatic order waiting in the wings to protect what’s left of our funds. However, this is a very dramatic move and should only be used as a last resort. Hopefully, you’re able to cut the losses earlier using well-practiced mental techniques before you ever find yourself in the position of needing such a dramatic action.
In addition to the four tools for a low risk portfolio that we laid out above, a general concept that all traders who are risk averse should be familiar with is starting from a small position and only increasing the size as the market moves in your favor.
The key here is that you can always add on, but you should not take the full position that you were originally allocated for. Only after the market has given you some profit to protect or to secure towards the direction should you make your move.
Along the same lines as disposing of your ego, you must understand that you cannot manipulate prices. To repeat, most of us are small players, and whatever orders we place in the market will not replace price. All we can do is enter and let the market greet us anyway it would. In this sense, we can control our attention to how the market changes while we’re in a position.
Because of this inability, we need to reassess our analysis over and over. We need to be very dynamic with how we manage the position. We need to modify our trade with new information that comes up constantly. This means positioning our targets and redefining the level that we think the market will have difficulty passing through. Always be on the lookout for the market to suddenly go against you. These are all things that need to be acted on.
As mentioned in the introduction, massive events can occur at any time by surprise. Events like political speeches where new rules are introduced, central banks interventions, a conflict between countries, natural disasters, etc. What happens to the market when a volcano erupts and stops air travel for weeks? Unexpected events that can happen in a minute are anomalies that we have no way of dealing with unless we are prepared.
Always consider that something adverse might happen. Start slow, build up protections, and then you can always add on like that.
So how do you build a successful low risk portfolio in such an environment?
Map all the possible scenarios you have experienced in the past according to your trading strategy. Write a detailed action plan for all such scenarios. This gives you a tool that allows you to always respond fast by triggering an action plan without thinking. It’s automatic, and it’s one of your best defenses. If, for some reason, it turns out to be wrong, take the loss, be happy that you had the action, and stuck to it.
Once you exit the market, fix the action plan, so the next time it’s implemented, it’s the right move. Don’t fix things while in a trade. Your judgment is under pressure, and it’s a bad environment to create a solution in.
If you don’t have a trading plan, you can download The5ers free PDF.
If you do not use the set and forget strategy remember the market is always changing, so you need to be able to do it as well.
Don’t be locked in on your analysis. Evolve as the market presents you with more information. Leave your ego at the door if you’re to make a successful, low risk portfolio.
A good trader knows that a low risk portfolio is built slowly, but everything can be lost quickly, so he cuts losses as soon as the market goes against his position.
Acknowledge that losses are part of the job, and you need to accept them and convince yourself that taking them according to the plan is a healthy behavior that will save you in the long run from harming your portfolio.
The outcome of a trade doesn’t make it a good one or a bad one. A good or bad trade is defined by being a trade placed following your trading plan and strategy, regardless of the outcome.
Work by the pre-planned actions and follow them like a well disciplined robot.
This is the exact reason why you created an action plan. Everything was written from your experience as a trader. Thanks to it, now you can act the right way and improve your statistics.
Did you forget to map something, or you missed a piece of the plan? Guess what? This happens to the best of us, at least in the beginning.
You should be tolerant and not beat yourself up over this type of mistake. Suppose you find the transgression while in a trade, the best thing to do is to exit the position. Don’t stay there because you don’t have a plan. Make this one of your master rules.
Get out, learn the scenario, and create a plan. Next time you’ll have your action plan ready for when it arises. Don’t be in the market when you have a hole in your plan. This is the most important of all the rules!
While nothing is certain and everything laid out above is merely a roadmap for avoiding the pitfalls a chaotic market might present, it’s ultimately up to you to foresee and properly set up a plan to navigate crises. If you pay attention to details and study and craft carefully, there is little reason that you cannot succeed and thrive even in the most volatile of markets.
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