We all have heard about the importance of risk management and how crucial it is to our success. However, nobody really talks about all the elements of the risk management. The most talked about risk management is market risk. Then credit risk. After that, you hear about counterparty and operational risks.
As a previous risk manager, I can tell you that all of these are important to your success. You need to look at your process and make sure that you have a great risk management system in place. There is one element of risk management that is seldom talked about and often overlooked. This element can make or break your trading success. Often, it is forgotten as part of the stress tests.
Have you guessed what it is?
If not, let me give you a hint. Depending on how you look at it, it can be consider part of counterparty or operational risk.
Some examples are as follows:
- Do you have occasions when you know what to do but you don’t do it? Then you wonder what happened. You get angry and frustrated. You start losing money. If you don’t stop yourself, before you know it, you are in a deep hole.
- Do you know of traders who have a system and know that their success is based on probabilities? However, they start picking and choosing which signal to pull the trigger on. Then they wonder why they are not making money consistently.
- Have you ever put a trade on and immediately started doubting yourself? You move your stops, and you realize if you had just left it alone, you would be more profitable?
Have you figured it out yet? If you have guessed that it is your mindset, you are correct.
All the above examples have one common thing – the human factor. Unless you have a completely automated system, you are the operator. Your results depend on you.
It does not matter what happens. It matters how you react to the event and where you put your focus on. You can have the best systems in place. However, if you don’t develop your Mental Edge and are not in the zone, you are not going to execute your trades properly and thus you will lose a lot of money.
This element is so important that JP Morgan has a group called the ‘Behavioral Finance Team’ which deals with how mindset influences the execution of their trades.
Your action plan for designing your risk management system is:
- Counterparty risk: Make sure your business plan matches who you are
- Operational risk: Put yourself in a supportive environment
- Counterparty and operational risks: Develop your Mental Edge
Risk management is vital. To ensure more successful execution of your trades and a consistent way of making money, make the above action plan part of your overall risk management system.
Nazy Massoud is a Wall Street Insider who shows traders, investors and hedge fund managers how to develop the mental edge to execute trades more profitably. For more articles and tips, go to http://www.mentaledgetrading.com.