If I had to think back, ‘What’s my attitude to risk?’ was definitely not the first question I asked myself when I initially started trading. I think it was ‘How do I get good at this?’ Perhaps if I had thought more about risk in the beginning I would have saved myself a lot of time. The reason for this is that a trader’s primary focus should be to protect capital by controlling risk, and one of the ways in which we attempt to control risk is to create structure around everything that we do; that’s basically creating routines and checklists.
There are two main categories of technical risk, trade risk and monetary risk. Trade risk is whether we use stops, we should, and where we place them. Monetary risk is how much of our capital we allocate per trade or to a group of trades.
Of equal importance, because technical risk relies on it, is our psychological risk profile. In simple terms, do we have a gambling mentality or an overcautious mentality? This is where our personality can really obstruct our development and future success; ironically we’d probably never find out what our attitude to risk is unless we’d become interested in trading in the first place.
A gambling mentality is far too focused on winning, and winning big! A trader with this mentality has no problem pressing the button and throwing huge chunks of their account at the market. The worst thing that can happen is that their first attempt is a winner which just reinforces their reckless behaviour, and they’ll keep going until there’s nothing left.
Conversely a cautious mentality is too focused on losing; these traders might not blow up their account but they’ll never make consistent money either. They’re too busy psyching themselves up to pull the trigger as their set-up goes on without them.
Obviously, any hindering personality trait will take time and effort to address, but one of the simplest and fastest ways to get your head into the right space is to use a checklist that you believe in.
Your checklist has to be specific and detailed, yet simply worded. Prioritise your entry criteria in order of importance, that way if your absolute minimum requirements aren’t met then you don’t have a trade set up and you leave it well alone.
Why a checklist is so fundamental is that regardless of our risk appetite, it forces us to engage with the process logically rather than emotionally. Let the checklist do the hard work of ‘deciding’ whether we should take the trade or not.
A checklist is like counting to ten, it helps us become more discerning in our trade set-ups. It could help keep a risk inclined person out of a bad trade, whereas paradoxically, it’ll encourage a risk averse person to take the trade.
We all want a cast iron guarantee, no luck there, but a reliable checklist is as close as we can get. When our checklist scores 9 out of 10, not to take the trade would be cheating ourselves. And conversely, if we take a trade that scores 5 out of 10 then we’d be deceiving ourselves; neither can lead to success.