THE ENTRY - While we're sitting back and waiting for the next trade, I thought it would be a good time to touch a bit on my risk management techniques. Many of you have reached out asking about my strategy and approach when it comes to risk management. While there is quite a bit of qualitative, discretionary overlay to my trading, there is also a method to the madness. So for today, let's talk a little bit about entry and stop-loss. So, one of the things about my strategy, is that I am always looking to trade markets that are highly overextended. This means there is a very good chance at some point soon after the trade is taken, the market will reverse quite aggressively and normalize. For me, the ideal entry point for a trade is the point at which every other contrarian has already tried and failed to establish the counter-trend position. Of course, as will be discussed, I can also fall victim to bad timing and suffer losses. But more often than not, I am successful catching a countertrend move.
OF COURSE MOMENT - I suppose one of the most frustrating things about taking a loss when you're a contrarian, is the knowing that once you exit for a loss, the market will probably be on the verge of a sizable reversal. This can be intensely frustrating. So what do I do? Well again, I try to enter the position when others have already tried and given up. I call this the "of course moment." It is the moment where these traders have tried, stopped out, and only then see the reversal they were looking for. All they can do is say "of course.....now it goes my way." So this is the moment I do my best to isolate as my entry point. I believe that when I establish the trade at the "of course moment" there should be very limited downside before the elastic snaps back sharply. But I still try to be super conservative and allow for 1) a sizable cushion, and 2) an opportunity to even build into the position if it moves against me.
NOT ABOUT A LEVEL - But where to exit if it all goes wrong? So with this strategy, it is less about a specific level to exit and more about the fact the market is violently overextended and shouldn't really extend much further. This means, I will say to myself, I don't believe the market will move another 3% from point of entry without a major correction that should translate into profit. I then find that level 3% away from entry and determine how much risk I want that 3% move to cost me. Let's say for simplicity the 3% is 300 points. So in this case, you determine what portion of your equity you want to risk if that market moves the 300 points.
EXAMPLE - I buy EURUSD at 1.1200 and say I don't believe it will go to 1.0900 before correcting sharply. I then decide that I am prepared to risk 1% of my total equity on this trade. Let's say 1% of my total equity is $1000. This means that if I were to buy at 1.1200, I would need to buy 33.3k EURUSD at 1.1200 with a stop loss at 1.0900. If the market went down to 1.0900, I would lose $999 (each pip is worth $3.33*300 pips =999). You could of course break up the trade and buy a smaller portion at 1.1200 and some more at 1.1050, with the total risk still equalling $1,000 (i like doing this). But the key takeaway is that 1) I define my stop-loss less on a specific level and more on how much cushion I think I need and 2) I then determine what % of equity I want that cushion to be. So again, in the case above I said 1) I don't think it will move below 1.0900 and 2) if it did go to 1.0900, I would be prepared to lose 1% of total equity. Hope this helps a bit.