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2 Alternative Risk Management Ideas That Can Fix Overtrading

October 02
22:49 2022

Risk management is the lifeline of every retail trader’s journey. If your trading capital is your life, you need to live healthy to preserve that lifespan. Therefore, the first objective as a retail trader in the forex market shouldn’t be making a profit; it should be staying in the game long enough to experience consistent profitability.

All traders, regardless of their skill level, would experience losses and losing streaks. This reality calls for a protection mechanism within your trading methodology. Some traders risk a lot to make a little, and some choose to take a lot of small losses to try and catch a big win. However, all these strategies can only go so far if you still enter too many trades relative to your system.

Hence, I would like to break down a few ideas to curb your overtrading, mainly for day traders.

Let’s begin.

1) Only trade 3 to 4 hours a day.

Retail trading is a game of probability; while some traders need a 70% accuracy on their trades to be profitable, some just need 40%. Hence each trader would lose a certain percentage of the time.

Take the trader with a 70% accuracy. He is likely to lose 30% of the time. This means for every ten trades, he is expected to lose 3, and for every 100, he is likely to lose 30 trades. Hence, with less accuracy and more trades taken, the more the losses that the trader would incur.

It then comes down to the one factor that controls your ability to find and take trades.

• Time

How much time you spend trading would determine the number of opportunities you can find within a day. The trick here is to constrain yourself within a routine of your trading style’s most effective trading times.

Day traders would mostly trade around the most active volume of the day. However, not all strategies require heavy volumes to be consistently profitable. Still, It can only help if the price is going fast in your direction.

Here at Day trading forex Live (DTFL). We try to anticipate what the major players (smart money) are going to react and be 1 step ahead of the rest of the retail market. To do this, we have to trade when these major players are the most active in the market.

Below is a 15 min timeframe chart displaying our valid trading hours.

Trading times

As you can see above, there are two valid sets of 3 to 4 hours of trading you can participate in daily. The objective here is to select the best of these two sessions that suit you for the optimal execution of trades.

You must make this selection based on your schedule and your trading style. It would be best to dedicate all your attention to the markets within that time window, as missing a trade due to distractions would have adverse consequences.

This would control your over trading and give you a unique view of any market you trade. You would spot the unique interaction with the volume and volatility each pair exhibits in that time window.

2) Cap your daily risk to a dollar amount

Here at DTFL, we have a standard of risking a maximum of 2% per trade and usually a maximum of 2 trades a day. These management rules keep you at a total risk of 4% of your entire capital a day.

However, I have realized that trading in terms of a dollar amount makes it more tangible to traders. So, an alternative way to do this would be to measure the total risk amount for the day in dollar value, then let that dictate the number of trades you take per day.

Now say 4% is $200; this means all you can risk for the day is $200. So the question you must ask yourself now is, “how much do I want to risk per trade?”.

There are two trains of thought I would consider in making this decision.

a) Confidence

After your 1st trade in a day, your confidence level is likely to change. You are likely to increase your confidence after a win and diminish after a loss. This suggests that you are at the best mental state on your 1st trade.

However, prospect theory suggests that the human mind is likely to be affected a lot more by a loss than it would be by a win. By this theory, a loss on your 1st trade is more likely to cause an adverse emotional reaction in the 2nd trade, and it gets worse the more trades you take. As your hunger to make back your money increases, the more you lose.

Hence the alternative risk management option here would be to risk a lot more of the daily allowance on your 1st trade of the day and less on the 2nd.

Example

Say you have a $200 daily limit as suggested above. Your 1st trade risk could be $140, while the second is $60. In a case where you want the ability to take three trades a day, you could trade $100 for the 1st and $50 for the 2nd and 3rd trades.

The value here is as the emotional burden increases with the number of trades, the financial burden reduces. This creates some balance with the mental pressure in your trading.

Consequence

The only consequence is the unevenness you might have in your result, as the 2nd or 3rd trades might be the better trades for the day. So now, instead of recovering your loss, you would end the day breakeven.

Therefore, I would only recommend using the above approach if you struggle with staying consistent with your plan after taking a win or a loss in the day.

b) Consistency

Consistency as a thought process solves the issue above, as you keep each trade at the same dollar risk amount as the other. We generally recommend this; you could start at a dollar amount you are comfortable losing per trade. Then, only use the 2% rule as a max point to not exceed per trade and 4% to not exceed per day.

Every adult knows how much they are comfortable letting go off every single day. This idea should be clear to you based on how you currently live your life. The objective here is to be self-aware of your current relationship with money. As that understanding would lead to you figuring out your exact risk parameters for trading.  

 

Thanks again for reading, and do not forget to leave a comment if you have any questions or suggestions.

Thanks

-Kevin Chima


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