Is understanding risk the holy grail of trading?

It might. You tell me (after reading this article).

Have you had a chance to think about risk? I mean, really think about what it is for traders? How can we use it on our favor, is it possible to eliminate risk?

Understanding Risk in Forex

If you haven’t, please do so … because once you understand what it really is (and accept it), you’ll trade with ease, you’ll trade with more confidence, you’ll be more disciplined and patient… and at the end, you’ll trade with better results.

I can guarantee it…

And you know something, in some cases, you might have already experienced what it is to accept and embrace risk (even unconsciously).

Oh men, when this happens, almost every trade goes on your favor, you get out of the market just when it starts to go against you, you take profits just at the right time, you trade the right trade-size, etc, etc, etc.

Everything is just right!

Have you gone through a phase like this?

I think every trade with enough experience has… And it’s a very very pleasant feeling!

You see, all these happens because you don’t block any type of information (more about this in a minute) that you’d block if you didn’t embrace risk.

Now the question is how can you get to trade like that every day?

Well, that’s what this article is about, you’ll find out when you are done with it.

Heh, there is no free lunch buddy!

Ok, we talked about accepting and embracing risk… but what happens when you don’t accept it?

If you don’t accept and embrace risk, things will get complicated, I can also guarantee you that. 

Unfortunately, there are also periods where every decision you take seems to be the wrong one, it would be something like the inverse-Midas touch.

These are the sort of the things that tend to happen when you dont accept risk:

  • Taking profits too early
  • Trading with no stop losses
  • Getting out of the trade to soon
  • Getting in to trades too soon
  • Taking larger trades than you are supposed to
  • Chasing the market
  • Letting the market go against you when in profits

When you make these mistakes over and over, it’s a very very unpleasant feeling.

Ok, So now, you got 2 scenarios:

A pleasant feeling: When you embrace risk

An unpleasant feeling: When you don’t accept risk

Which one would you choose?

Looks like an easy answer right? But then why is it that we keep making the same mistakes over and over?

So maybe you have not fully embraced risk?

Think about it, specially think about how you can improve your trading results once you embrace risk.

Every trade would be like the first scenario, over and over. You’d take profits at the right time, you’ll be choosing the right currency pairs to trade, you’ll be trading the right trading size, etc.

Like this scenario?

Ok, then keep reading :)

There is just one way to get rid of risk

That’s right, there is just one way to get rid of risk on your trading, and it is:

Quit trading.

Forex Trading

I suspect though that since you are reading this article, you want to keep trading, so I will not consider that quit trading is a possibility for you. Or is it?

So please, stop wasting time and resources trying to eliminate risk (aka looking for a system that is right 100% of the time), because it is just impossible to do.

Risk is what defines us as traders, it’s part of what we are, it’s our identity.

What do we do as traders?

We risk an amount of money to get another amount of money.

risk money + get more money = Trader

That’s the equation that defines us, that’s what we are. We are risk takers.

We need both sides of the equation, we need to risk money to get more money, there is no  way around it.

Let me ask you another question: when you open a trade, do you really accept the fact the market has the possibility to go against you?

Let say you open a trade, you use a 30 pip stop loss and a 50 pip take profit order.

Do you accept the fact that the market could move against you? The possibility of getting stopped out? The possibility that you took the wrong decision?

Or you just think about the profit side, about how much time it will take the market to get there, that once your TP gets hit, you are going to be +5%, etc?

Of course we all want the market to move on our favor, but that it is just one possibility, there also the other possibility, the market could move against you.

There is no way we can get rid of any part of the equation, so think about it, when ever you open a trade, two things can happen:

  • The market moves on your favor, or
  • The market moves against you

It doesn’t matter what trading system you use, what market you trade, what currencies you choose to trade, anything. We’ll always have these two possibilities and you need to learn to live with it.

Why fear makes you block information

Trading Psychology

Our brain is wired in a way that it tries to avoid all information that is painful for us, that’s just the way it works, whether we like it or not, it’s human nature.

How is this related to trading?

Think about this, if you fear something like: losing a trade. How would this affect you?

For obvious reasons you want to win this trade, and so does your brain. So as an effort to “not experience” a losing trade, your brain will start to block any information that tells you that the market will go against you.

This mechanism is triggered automatically, you don’t have to consciously think about this to trigger it.

So your brain blocks the information that would had helped you to get out of the trade (i.e. a reversal signal), but for you its impossible to see it because your brain doesn’t want you to experience a losing trade.

This is why everything becomes so clear and apparent once everything is over. Why I didn’t see this? Why I didn’t see that? The market was obviously going against me, why I didn’t close my trade sooner.

Well, the answer is that your brain was blocking this information from you.

Since there is no way to have “the serious talk” with your brain to stop blocking this information from you, you can approach this through a different angle:

Not being afraid.

If you are not afraid (i.e. of getting stopped out) your brain wont block any information from you.

And the only way to the rid of fear is by accepting and embracing risk.

Are you still with me?

Accepting and Embracing Risk

Accept Risk

These are some of the most common fears in trading:

Taking profits too early

What is feared: When you take profits too early, you fear that the market will go against you and everything you have earned in that trade will get vanished.

Accept risk: When you analyzed the market and decided to take that trade, you also thought about the stop loss and take profits order. Why would you take profits now in the heat of the moment, if you had a well structured trading plan?

Remember, the best trading decisions are always taken before your trade takes place.

To take full advantage of the market swings, you need accept the fact that sometimes the market will go against you. Just accept it.

What’s good is that most of the time, the market will continue in your favor.

Trading with no stop losses

What is feared: When you trade with no stop losses you are only taking in consideration part of the equation (the “get more money” side) and blocking the fact that the market has the possibility to move against you.

Accept risk: Accept the fact that the market has the possibility to move against you. Once you train your brain to think like this, you will force yourself to use stop loss orders.

What is sad about not using stop loss orders is that if the market goes against you by the right amount of pips, you are going to blow out your account.

Is it worth it? To risk your complete account just because you are not considering losing one trade?

By the way, mental stops are just the same thing as no using stop losses at all.

Getting in to trades too soon

What is feared: That you are going to miss out an opportunity to trade.

Accept risk: It’s impossible to take advantage of every market swing.

Yes, sometimes the market will move without you, there is just no way of capturing every market move.

Just focus on the ones your system signals, only then is when you have a real opportunity, a low risk trading opportunity.

You never know before the fact if your signal is going to get triggered. Patiently wait for the right moment.

Taking more risks than you are supposed to

What is feared: You are not going to get the results you hoped for, to make up for it, you start taking more risks.

Accept risk: You need to be patient.

You need to know that every trade has the possibility to move against you, so if you start risking more capital and the market goes against you, you’ll be in a very unfavorable position.

It’s always better, to risk what you are supposed to risk according to your plan, nothing more.

Trading in the Zone

Mark Douglas in his book Trading in the zone puts it as clear as water:

Accepting risk means accepting the consequences of your trades without emotional discomfort or fear. This means that you must learn how to think about trading and your relationship with the market in such a way that the possibility of being wrong, losing, missing out, or leaving money in the table doesn’t cause your mental defense mechanisms to kick in and take you out of the opportunity flow. It doesn’t do you any good to take the risk of putting on a trade if you are afraid of the consequences, because your fears will act on the perception of information and your behavior in a way that will cause you to create the very experience you fear the most, the one you are trying to avoid

Then he adds:

This is where professional traders really separate themselves from the crowd. When you accept the risk the way the pros do, you wont perceive anything that the market can do as threatening. If nothing is threatening, there is nothing to fear .If you are not afraid, you don’t need courage. If you are not stressed, why would you need nerves of steel?

What do you think?

Your Turn

What are your thoughts about risk? Do you think its an important aspect of trading? Even more important than the strategy, entry system and the like?

What do you do to accept risk? Please share any strategy that could help other traders deal with risk.

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Raul Lopez

I've been trading the markets for more than 15 years. I believe the best way to trade is by adapting to the market conditions. You can learn it too, join our community .

  • pduarte

    Hello Raul,

    Once again, you’r absolutely right. In life to have success we need 20% of transpiration an 80% of inspiration, but in trading we need 50% of good analysis and 50% of good psychology, because that is what separates a bad/medium trader of a good trader. When we enter a trade all the pre-work must be allready done, an that mean’s that we must have a reason to open a trade, were do we will take profit ( or partial profit) and very important were do we put our stop loss, and our stop loss must be at a level were, if the market reach that level, than, that means that the reason why we took that trade is not valid anymore. In resume trading is all about good analysis and good emotional management. I think that, there are two characteristics, that a trader must have, one is confidence, because with that we can take all the profit that a trade could give us, the other is humility, because with that, we can see sooner that we are in a bad trade, and in that case the sooner the better.

    What do you think about this?


    Paulo Duarte

    • Raul Lopez

      Hey Paulo, 

      Thank you for your thorough comment! You nailed it down! :)

      I definitely agree with you, confidence is a must for every trader. You need to types of confidence: in yourself and the system you are using. The only way to get both, is by using and following your system to a 100%. 

      Humility is another important factor, but dont worry to much about this one, because once you think you know it all, the market will make you understand that you dont know a thing hehe

      By the way, I’ve been trying to contact you through email… have you got them? 

      Let me know. 

      Thank you again for the insights you share on your comments! 

  • Great article.. came here from your newsletter. Just yesterday, I sent over a two part article that I wrote up about stop losses.

    Now coming to the fact, risk is indeed a part of trading and in fact is the reason why there is a successful trade in the first place. One way to manage risk is to place stops correctly so when instead of retracing the market reverses, you are stopped out and your capital preserved.

    Having been on both sides of the fence, I must say that no amount of words/books can drive home the point. One has to trade, take profits quickly, let losses run and do the usual thing before getting a hang of utilizing risk correctly.

    • Raul Lopez

      Is your name XAGUSD???? Please use your name. I dont care about the link to your site, but dont use it just for backlinking purposes…

      Alright, now to the fact… I do agree with you, to force yourself to use stop loss orders is a great way to accept  the risk inherited from each trade.