Archive | August, 2012

Risk Management in the Infield

If you’ve ever watched baseball, then you’ve probably seen some spectacular double plays. But you’ll also notice there are times when the fielders don’t try to get both outs. This is a real-world example of risk management.

There are certain circumstances that make turning a double play too risky for the fielder, and they know they can’t afford to mess up! Two runners on base are exponentially more dangerous than one. So, what do they do? They throw straight to first base to get the sure out! Just as the fielders sometimes have to bite the bullet to ensure they get the out, we as traders have to get used to taking hits before we find good market positions.

While it would be nice to believe you’re going to generate profits on every trade, the reality is that you won’t. Sometimes you lose trades and runners advance, but if you remember the fundamentals of risk management, you’ll be a profitable trader. Small losses (a single runner) are much easier to overcome than large ones (two runners). Your efforts should be focused on minimizing the damage inflicted by the losing trades that will inevitably come.

Just remember this simple formula: Big Winners + Small Losers = Profitable Trading

 

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