Risk Control and Consistency; A Trader’s Dual Mandate
Author: Bobby Iaccino / Founder-Chief Strategist Path Trading Partners
Noun. An official order or commission to do something. Examples:
"A mandate from the president to seek the release of political prisoners"
"A dual mandate from yourself to yourself, to control your risk and be consistent in your behavior when trading"
One of the main inputs traders and investors watch on a week to week basis is where the U.S Federal Reserve Bank is in the pursuit of its dual mandate. Most don’t know however, that the Fed actually has 3 mandates. The United States Congress established three key objectives for monetary policy in the Federal Reserve Act: maximizing employment, stabilizing prices, and moderating long-term interest rates. The first two objectives are mostly referred to as the Federal Reserve's dual mandate. Why is the third mandate left off? Because most economist and market observers believe long-term rates can be moderated by controlling the first two objectives. If the U.S. economy is moving along in a stable price environment with full or near full employment, then long-term rates will be stable. This has been demonstrably true throughout our history and is not really in dispute; hence the tri-mandate is functionally a dual mandate.
Successful traders also have a tri-mandate. They are risk control, consistency and profitability. Here’s the rub: If a trader is controlling risk and trading in a consistent way, then long-term profitability will likely be there eventually, hence the tri-mandate is functionally a dual mandate. Let’s explore the “what” of the dual mandate and then demonstrate how it leads to possible long-term profitability.
Starting with risk control, there’s a statement traders must imprint on their brains. Reward and risk are inexorable; you cannot have reward without risk….period. In other words, you cannot eliminate risk, you can only control it. Point number 1: Trying to eliminate risk in trading is “risk avoidance”, not risk control and risk avoidance is simply not possible in life or in trading. Learning to control risk should not be a scary or unfamiliar thought, as you make decisions every day in which you measure the risk of an action against the potential reward. When you choose to cross the street against the traffic light because you are late for a job interview, but choose not to cross the same street against the traffic light when you are late for coffee with mom, you have made 2 separate reward/risk calculations involving the same risk, but ended up with different decisions based on different potential rewards. You even make risk control decisions without knowing it.
For example, falling out of bed kills 450 people in the United States every year according to the Center for Disease Control, but not many of us think really hard before hitting the sack for a good night’s sleep. “Hmmmm, I wonder if I should stay awake all night or strap myself in so that I don’t DIE!” According to a Canadian research group, 13 people a year are killed by falling vending machines. "Maybe I’ll bring an apple to work instead of getting those Cheetos so I don’t DIE".
This brings us to point number 2 about risk. You can only control risks of which you are aware. On January 15th of 2015 the Swiss National Bank (SNB) shocked the markets when it scrapped its three-year-old peg of 1.20 Swiss francs per euro without warning. Within a few minutes after the central bank's announcement, the Swiss franc soared by around 30 percent in value against the Euro and 25% against the U.S. dollar. There was no hint given by the SNB prior to taking this action and traders were stunned. Some small FX firms actually went under from the losses they sustained. The only way to control these kinds of rare “uber-risks” is either to not trade or find vehicles where your risk is predetermined (more on this later). Choosing not to trade because of rare occurrences like the SNB surprise is like not taking a great job because the building you are to be working in may someday burn down. That is not a reward to risk calculation, that is risk avoidance and it has no place in trading. Controlling risk is about the amount of money you are willing to lose to achieve a certain gain and the way in which you control that capital’s exposure. This, as a trader is your number one job and the skill set you need to master before you can take trading seriously.
You master things like risk control through consistency. This is a tough concept to accept, but it is critical. Obviously, we trade for profit, but being consistent in trading is more important that being profitable. Consistency without profitability can be fixed. Profitability without consistency CANNOT be sustained. If you made money but can't replicate the analysis or verify the method, that's called luck. Consistency means, being consistent in your actions, both process-wise and personally. Wake up at the same time, start work at the same time, go to the gym at the same time. Develop consistent habits around your trading, whether you trade full-time or part time. Most importantly though, strive to be consistent in your trading approach.
Use the same monetary risk on all trades, preferably a percentage of total capital available. This helps you bump up monetary risk during profitable streaks and scale back during losing streaks. Keep a journal religiously, and take time out of your week to review your analysis. Did you take trades that were inconstant with your risk? Did you take trades out of emotion rather than your method? Did you miss trades without a good reason? Again and this can’t be stressed enough, if you made money but can't replicate the analysis or verify the method that generated that trade, it was luck. Ask any professional who is successful at any one task and they will tell you they got there through consistency and repetition. When a pitcher in major league baseball is suddenly seeing decreased velocity or control in his pitches, he and the coaches will go review film and see if his mechanics have changed, looking to see if he is no longer consistent in his actions. They don’t do this after one errant pitch or one home run given up. They do it after a significant change in overall production and they are only able to do this at all because they have consistent past behavior to compare to current behavior. Through consistency, one gains clarity.
So control risk and be consistent in the behavior that deems you take risk and you will see your own path to possible profitability. Nadex binary options and spreads can help in that consistency by providing the risk control tool that many people struggle with and that tool is built right into the products themselves. If you struggle with earth concept because you strive only to be profitable, then learn about Nadex before you give up on the goal of becoming a successful trader.
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