The Ugly Truth About Risk and Scoring Profits

The two-minute warning has long since passed, 30 seconds remain on the clock and your favorite team is making a charge for the playoffs. Watching the starting quarterback in the shotgun formation, you have only two thoughts — first down or score.

If you’re an ‘elite’ championship-level NFL quarterback, those thoughts are fourth or fifth on your list of priorities. Your number one job — even with the playoffs on the line: protect the ball and avoid a costly turnover.

Sure — glory, ESPN highlights and YouTube views go to the jaw-dropping throws and catches. But the franchise contracts and $100 million contracts go to the ‘gunslingers’ who make smart decisions that keep their team in the game — giving them a chance to score.

As a trader, an imbalanced focus on scoring profits that doesn’t equally emphasize risk management is a great way to send your account packing. The ugly truth is that risk management comes well before profits. Effective risk management is easily incorporated and will keep you trading for a long time — as long as you have the discipline to stick with it.

A vital function that millions of traders overlook

Everyone has an opinion about their team’s favorite quarterback. When was the last time you bragged about their average interception per game stat?

Interceptions are only bemoaned when they’re thrown — but the work that goes into avoiding them is often overlooked in favor of the razzle-dazzle of big scoring drives.

Unfortunately most retail traders don’t really even have a sense of their ‘interception per game’ stat equivalent. Even though they are the quarterback of their business — and their trades — they are focused on scoring profits, not managing risk.

This imbalanced focus on profits is only compounded by the promotions for every indicator, signal and twizzler currently flooding the marketplace. The ugly truth that many traders don’t want to accept: Like an NFL quarterback, they are a risk manager first — and a playmaker second.

Two simple ways to keep risk in check

When a quarterback drops back in the pocket and coils up to make a pass, it’s only done after he’s determined that the odds for turning the ball over are low. This is done after completing a progression of checks across the defense and his passing options.

These checks are designed to decrease the likelihood of a loss. You can easily implement basic ‘checks’ of your own that protect your account from catastrophic setbacks. When implemented properly, they help you embrace your role as a risk manager, which in itself is a powerful offensive asset.

Start with your business and ensure that you have loss limit built into your projections. If you simply have profit targets, you’ll have no sense of the losses you can afford to absorb along your path to your goal. The loss limit should be broken into annual, monthly, weekly, daily, and yes — per trade — amounts.

With that in place – prepare to add the following ‘checks’ into your trading regime:

  • Risk/Reward Ratio: Understand exactly what you’re willing to risk and the reward you’re willing to take. Express this in the form of a ratio. For example: if you’re willing to risk a dollar to make a dollar, your ratio will be 1:1. Arrive at a ratio that’s appropriate for your trading strategy. For scalpers, this is usually 1:1 to 1:2. Swing traders will be more aggressive with 1:3 to 1:4.
  • ATM (Advanced Trade Management) Strategy: Put your ratio(s) into action with the ATM tool found within the chart trader of NinjaTrader. When activated, this will ensure that profit targets and catastrophic stops are automatically put into place.

With these two steps, you will have brought a major component of your risk management directly to your chart — alongside you and every trade you enter.

Risk management first, profits second

Before the ball is even snapped, an elite quarterback is capable of reading the defence and adjusting accordingly. Some are legendary for the audible calls they make at the line of scrimmage, based on what they see. (Insert your favorite Peyton Manning, arms-waving-in-the-air joke here…)

Above all, if they don’t like what they see — they call a timeout. If they get into the play and don’t see an option — they throw the ball away or take a sack. Better to keep the drive alive or stay in the game.

As a trader, your role as a risk manager comes first. Doing so preserves your capital and keeps your account in the game. When you don’t see a high probability trade — don’t make the entry. Live to make another trade.

When in a trade, having a catastrophic stop in place will help ensure that your risk tolerance and reward expectations are represented. Using NinjaTrader’s ATM ensures that these protections are in place with every trade. It will also provide another firewall should you decide to go against your better instincts and ‘run and gun’ with your trade.

NOT having this in place makes your role as a risk manager much more difficult — just when your account needs it most (all the time).

Why choosing a prevent defense is better than run and gun

Head coach Jimmy Johnson held his foot on the gas for most of the games he coached in Miami, with his famous ‘run ‘n gun’ offense. The basic premise: Defensive setbacks can be overcome simply by running up the score.

Many traders believe that focusing on risk isn’t empowering — and places them on the sidelines when they could be scoring and building their account. You’ll find this philosophy squarely among the 95% of retail traders in the market — most of whom don’t make it.

Walk the floor of an institutional trading house (the NFL equivalent) and you’ll hear about mitigating risk before you hear about profits. Pull an institutional trader aside and ask her (or him) why they like a trade and they’ll talk ‘acceptable risk’ for ‘attractive reward’.

The run ‘n gun offense was appealing to fans, but didn’t create dynasties. The same is true for your account — better to go with a prevent defense.

Embrace risk management tools that protect profits

Four-time Super Bowl champion Tom Brady processes the information he needs to decide whether he’s going to make a pass in less than three seconds. That’s right — he reads the defense, tracks his receivers and has the ball out of his hands in about 2.5 seconds on average.

You can process the information you need to save your account in seconds as well. It starts well before you even contemplate your first entry or spot your location.

If you haven’t yet formulated a plan for your trading business, start today. Outline attainable goals for daily, weekly, monthly and yearly profits. Then outline your expectations for losses — for each day, week, month and this year. Be realistic. Plan for the worst.

Incorporate these targets into your daily trading regime. When you hit your daily loss target, even if it’s early in the trading

day — take a seat and save your capital. Use the ATM (Automated Trading Strategy) as a matter of standard operating procedure to ensure you have a stop for catastrophic losses.

Keep your account on the field so that you can enjoy the profits when they come.

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