01 - Class 01 - Managing Risk

Advanced Options Training: Risky Business Class 1: Risk Management
Class 1: - Risk Management

Today’s Objective
• Risk management overview and psychology of risk
• Explanation of a Risk Unit (R)
• Explanation of incorporating R into your trading plan with examples
• ROI versus R
l,
• Compounding R Trading m e a p rofessiona
System To beco r For Life
Trade t become a
t firs nt
you mus k Manageme
of Ris
Master
“Every Major Loss I have had trading has come from

believing my current trade would be a big winner, so I
did not follow the rules of the game. I must adopt my
belief system that, ‘THIS TRADE WILL MOST LIKELY BE A
LOSER’ and you sure as heck better protect yourself” Sami Abusaad
PAGE 1
Mastering Risk
• Trading knowledge (including technical analysis, strategies, chart reading and
pattern recognition) are all critical BUT…alone are not enough to make you
a successful trader
• A trader must become a Master of Risk Management in order to
breakthrough to the professional level of trading
Have you ever found yourself having a nice streak of winning trades and making money,
and then in one or two trades you give all those profits back?
PAGE 2
Mastering Risk (Continued)

• The most effective and fastest way for a trader to become consistently
profitable is to NOT trade for money BUT RATHER trade to
acquire skill.
• The best way to accomplish this is to measure your trading results based on
Risk Units rather than Return on Investment (ROI)
Risk Unit (R)
• Risk Unit (R) Defined: The amount

a trader is willing to lose on a trade
if it hits his or her stop.
• R is also used to calculate the profit
a trader would make on a trade if
his target is achieved. This is how a
Risk-Reward ratio is established
• R’s are based on real gains or losses
in the trader’s account and not a
percentage
• A stop price is the point on the
chart that the probability of the trade working as originally planned does not
exist anymore. (pattern is broken)
• The Stop Price is figured from the chart, not by a percent amount or a dollar
amount
• There is NEVER an instance when the stop price is not determined before
entering the trade
• Always use a HARD STOP on every trade until a target is reached and then a
trail stop is acceptable. (will discuss more in trade management chapter)
• Stops are your friend, not your enemy
• Stops allow traders to limit their losses and preserve their trading capital
• Professional traders do not adjust their stops once hit.
PAGE 3
Stops And Risk Management

• Your “R” allows you to know upfront your maximum loss for each trade
• Your stop price keeps you from losing more than your R on a losing trade
• Upon entering the trade, you have completely accepted the possibility of the
maximum loss
• If that loss amount (your R) is not acceptable or too painful, then you simply
must lower your R
• Your “R” must always be the same amount for each trade taken over a
predetermined amount of trading days or trades. Picking different R’s for
each trade will never lead a trader to long term consistent profitability.
• To achieve the overall results you want, you must let your analysis play out on
each trade with the same Risk
• Your predetermined acceptable Risk Unit removes the emotion from your
trade once you enter
PAGE 4
ROI vs. ROR

Hidden Dangers of ROI
• ROI keeps you focused only on a return for one trade
• ROI keeps you focused only on the return and not the risk
• The amount of Investment is irrelevant without Risk
• ROI doesn’t provide an overall measurement
Benefits of Trading R’s

• R to R measurement keeps your eye
on consistency
• Trading for R’s removes the emotion of money
• Trading for R keeps your losses limited to
set amount
• Builds the muscle to increase your size of trades profits in a controlled
manner over a set period of time
PAGE 5
Determining Your R
• A trader’s R should be no more than 2% of their cash account value:
➡ With a $2,500 account you would be trading a $50 R
➡ With a $10,000 account you would be trading a $200 R
• Therefore, no more than 2% of your account should ever be at risk
on a trade
Dealing With Loss

• Assuming a $2,500 account, you now know your R value is $50
• Now let’s manage risk!
➡ Limit loss per trade to $50.00 (1R)
➡ Limit loss per day to $150.00 (3R)
➡ Limit loss per week to $300.00 (6R)
Trading R’s
• To determine how many shares (or contracts) to buy, divide R by the size of
your stop.
➡ $50R ÷ $0.25 Stop = 200 Shares
➡ $50R ÷ $2.00 Stop = 25 Shares
➡ $100R ÷ $0.25 Stop = 400 Shares
➡ $100R ÷ $2.00 Stop = 50 Shares
PAGE 6
Rules For Trading R’s

• The stop price for a trade is ALWAYS predetermined through analysis.
• Your R unit is ALWAYS determined by your current account size.
• The size of your entry (shares or contracts) is ALWAYS calculated based on
your R unit and Stop value.
PAGE 7
Will you ever again will you ever take a trade without a
predetermined stop or predetermined R unit?
…When would now be a good time to make a change?
Pop-Quiz
When do you determine a target for a trade?
• Before entering
• After entering
• While stock is moving in intended direction of trade?
5 Steps to Trading R’s

Step 1: Determine your R for each trade to be used consistently over a period
of one month or 20 trades, whichever comes first
Step 2: Determine your entry price and then stop price based on the chart. For
example, buy XYZ at 30 and stop will be 29.50
Step 3: Calculate how many shares or contracts to purchase by taking your R
unit and dividing it by your stop
Step 4: Identify target based on the chart and calculate R’s
Step 5: If R to R is at least 3 to 1 then enter trade when it triggers
Regardless of how nice the pattern is, how great it looks, how
strongly you believe the trade will go in the direction you think,
how badly you want to prove you are right, the bottom line is
that unless a trade has a reward to risk potential of
at least 3 to 1 it is not the best trade to risk an R.
PAGE 8
Pop-Quiz
What winning trade percentage do you need to consistently make money?
• 30%
• 40%
• 50%
• 60%
• 70%
Risk to Reward
• Trading a 1 to 1 Risk to Reward Ratio requires that you have an extremely
high winning trade percentage to consistently be profitable
• Additionally it will require you taking a lot of trades to make any significant
money, and more trades means more commission and more chances for
error and mistakes
• Must change your focus and mindset to take trades that have realistic
potential to reach a 3R target
PAGE 9
Compounding R System
• An individualized and unique risk management system
• A systemized plan that allows a trader to acquire skill and develop
consistency in their trading
• A plan that removes the emotion of dollar counting or trading for money
• A plan that rewards your discipline and consistency and advances your R
after you achieve certain goals
• A plan that grows your account without the big setbacks
Homework
• Print out the last 3 trades you placed
• Mark Entry, Stop and Target(s)
• What was the risk for each trade and was it same amount for each?
• What was your Reward to Risk?
PAGE 10

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01 - Class 01 - Managing Risk

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What is a risk unit (R)?

What are the steps to trading using risk units?

Advanced Options Training: Risky Business Class 1: Risk Management

Class 1: - Risk Management

“Every Major Loss I have had trading has come from

Mastering Risk (Continued)

Risk Unit (R)

• Risk Unit (R) Defined: The amount

Stops And Risk Management

ROI vs. ROR

Benefits of Trading R’s

Dealing With Loss

Rules For Trading R’s

5 Steps to Trading R’s

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