We’re Paid to Take Risks: Embracing the Calculated Gamble in Trading
There’s a common saying in the trading world: “Scared money don’t make money.” It’s often used to justify reckless behavior, but at its core, there’s a fundamental truth. We are paid to take risks. Not blind, reckless risks, but calculated, well-defined risks. The problem is, many retail traders, especially those starting out, misunderstand what “taking risk” actually means. They equate it with gambling, with throwing caution to the wind and hoping for the best. That’s a recipe for disaster.
The Professional Trader’s Perspective: Risk as a Job Requirement
Consider the environment of a professional trading floor, whether at a bank, a hedge fund, or a proprietary trading firm. These traders aren’t playing with their own money; they’re managing the firm’s capital. And what are they paid to do? They’re paid to identify and exploit opportunities in the market, which inherently involves taking risks.
Think about Steve Ruffley. Now, I’m not advocating for his specific style – trading without stop losses and risking substantial portions of capital on individual trades is far too extreme for most. But his approach, rooted in his experience on trading floors, highlights a crucial point: professional traders are expected to take risks.
It’s not about being reckless; it’s about understanding that risk is a necessary component of generating returns. The key is to manage that risk within a well-defined framework. On a trading floor, that framework might involve strict position limits, daily loss limits, and oversight from a risk management department. If a trader exceeds their risk parameters, they’re stopped out for the day – but they’re often given another chance in the afternoon or the next day. The firm wants them to take risks, as long as those risks are calculated and within acceptable boundaries.
The Difference Between Calculated Risk and Gambling
The crucial distinction here is between calculated risk and gambling. Gambling is throwing money at something with a low probability of success, hoping for a lucky outcome. Calculated risk, on the other hand, involves:
- Identifying an Edge: This could be a technical pattern, a fundamental imbalance, a statistical anomaly, or any other factor that suggests a higher probability of one outcome over another.
- Defining Your Risk: Knowing exactly how much you’re willing to lose on the trade before you enter it. This is your stop-loss level, whether it’s a hard stop or a mental stop.
- Sizing Appropriately: Position sizing should be determined by your risk tolerance and your account size, not by your emotions or your desire to get rich quick.
- Having a Plan: Knowing when you’ll exit the trade, both in profit and in loss. This includes having a target price (or a trailing stop) and being prepared to cut losses if the trade moves against you.
- Acceptance of Losses: Recognizing that losing trades are unavoidable, it’s part of the process. No system or strategy will ever have a 100% win rate.
The “No Risk, No Reward” Fallacy
Many new traders fall into the trap of trying to eliminate risk entirely. They search for “holy grail” systems that promise guaranteed profits. They use tiny stop losses, hoping to avoid any pain. They close trades at the first sign of adversity.
But this approach is fundamentally flawed. You can’t eliminate risk; you can only manage it. And if you try to eliminate risk completely, you also eliminate the potential for significant rewards.
The Prop Firm Conundrum
Prop firms (proprietary trading firms) have become increasingly popular, offering traders access to larger capital in exchange for a profit split. However, the prop firm model often creates a perverse incentive structure. Traders are tempted to take excessive risks to pass the evaluation challenges quickly, and the firms themselves may have questionable practices.
The recent issues with MyForexFunds (MFF) highlight the dangers of this model. While prop firms can provide an opportunity, it’s crucial to approach them with caution and to understand the inherent risks. The focus should always be on developing a sustainable, long-term trading approach, not on “gaming” the system.
Finding Your Risk Comfort Zone
The key is to find a level of risk that you’re comfortable with, that allows you to trade without being overwhelmed by fear or greed, and that aligns with your overall trading strategy. This might mean:
- Starting Small: Begin with a small account size and low leverage.
- Focusing on High-Probability Setups: Don’t chase every move. Wait for the trades that offer the best risk/reward ratio.
- Using Wider Stops (with Smaller Size): Give your trades room to breathe, while still controlling your overall risk.
- Taking Partial Profits: Lock in some gains along the way, reducing your risk and securing some profit.
- Trailing Stops: Use trailing stops to protect profits as the trade moves in your favor.
- Limiting Number of Daily Trades: Limit the urge to ‘get back’ lost trades, or compound errors, by having a clear number of trades, and stopping when hit.
Conclusion:
Trading is inherently risky. There’s no way around it. But by embracing calculated risk, developing a solid trading plan, and mastering your emotions, you can significantly increase your chances of success. Don’t be afraid to take risks, but do so intelligently, with a clear understanding of the potential consequences. And remember, even the best traders in the world experience losses. It’s how you manage those losses, and how you learn from them, that ultimately determines your long-term profitability. Don’t be afraid to be wrong, just be sure to cut losses before they wipe you out.