Good Traders Come to Terms With Risk

 | Dec 01, 2016 | 1:00 PM EST
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This commentary originally appeared on Real Money Pro at noon ET today. Click here to learn about this dynamic market information service for active traders.

Last week's jobless claims rose by 17,000, the highest level since June. And if you recall, June was a pretty horrendous month for stocks, with the S&P falling 5%. Are we set up for a similar selloff? After all, the S&P is up 10% since that late-June low. 

I really don't see that as a possibility, though a trading plan should take into account the possibility of such a selloff. There are dissimilarities between successful professional traders and those who see trading more as an avocation. This latter group is very interested in trading. They really love the market and probably watch Fast Money and/or Mad Money. They may even tune into Fox News on Saturday to watch Bull and Bear. They are trading "enthusiasts." Simply put, they just love it! 

If you were to ask the first group of people what they did for a living, they'd tell you they were traders. They trade for a living. If you probed deeper, you'd soon realize this unique group of people doesn't just trade. They don't just trade "for a living." They view themselves as traders. Trading is in their blood. It is a part of them. It's who they are. They truly identify with trading. If they couldn't trade, they would be in crisis because (1), their income would stop; and (2), they would lose part of their identity. 

They all have one thing in common when it comes to trading. Their primary attention is given to risk. To losses. They figure the profits will take care of themselves, but if they get whacked really badly, the losses will take care of them! When you take a big loss, your ability to make a living is severely compromised. A farmer who loses the majority of his seeds is unable to plant a full crop. Come harvest time, that's a problem. Similarly, a trader who loses the majority of his capital is unable to trade. That's a problem, too. 

So we can stay in the business of trading if we pay strict attention to risk management. When the risk is managed appropriately, then the career is preserved. And if you fall into the category of "trading enthusiast," then you can bridge the gap between where you are and where you want to be by resolving to focus on how much money you can lose on each trade. Is it OK to lose that much money, or would it be a disaster? If the risk you take is appropriate, then a loss bums you out, but it doesn't clean you out. 

In this market, after the move it has made, you can still participate as a bullish trader if you simply focus on risk. There are many stocks that are clearly overbought and even pausing in their moves. The banks come to mind. So don't buy 'em, right? Well, it is a higher-risk trade to buy Goldman Sachs GS, Morgan Stanley MS or JPMorgan JPM right now. They've jumped about 20% since the election. They've been drifting sideways for the past week or so, right? And since they've been drifting sideways, the move is over, right? 

Well, perhaps not. 

Goldman Sachs gapped up yesterday on news that a former manager has been appointed to run the Treasury. It's up 3.5%. So the stock was not rolling over; it was resting. This is a stock that now actually presents a trade with defined risk. Buying the stock now enables you to use a risk management stop of 5% -- stopping yourself out if GS falls below recent support at $210. This is how a professional trader thinks. And with 6.5 million shares trading yesterday, believe me when I tell you there was professional money behind that move. 

So focusing on risk enables you to see things that you'd normally pass over because you felt the risk was too high. And on the other side of the coin, ignoring risk can result in you getting into stocks with huge risk that you aren't even considering. 

Be careful out there.

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