Part 3 of 4
NEW YORK (TheGoldAndOilGuy.com) -- Mistake #3 -- Failing to Control Risk
If you were to engage in something risky like skydiving, you or a team would check your parachute to be sure it's packed properly, strapped on to your body correctly before you jumped out of the plane.
If for some reason you were not told how to use the gear, like when to pull the ripcord, etc., I guarantee you would ask before you threw your body out of the plane. There is a real fear of dying, so you naturally make sure you are in control of what you are about to do so your risk is managed and you can live another day.
But when it comes to trading, this is not the case. You and I both know a good part of why. We all know people who have said rude things, quit jobs or broken up with a girlfriend or boyfriend over the Internet (email/text message).
Let's face it, it's easy to be brave online and do things we would never really do in person. Heck, some of the emails I get from readers are so rude and some are threatening that all I can do is laugh. Because I know these people would likely never say the things they did to someone they have never met, and do it to their face because they think my short-term market prediction does not fit their bias. I think you get the point here.
So when it comes to trading, individuals get this what I call "online courage," and this is why so many fail to protect their capital when trading. They simply don't see their money, so it does not feel at risk (out of sight is out of mind). This lack of fear is what leads to loss of risk control.
How to Avoid Mistake #3
There are a few things that can and should be done to control your overall risk when trading. The first one is diversification. Not having all your trading capital in one investment allows you to spread your risk between other investments with low correlation -- meaning if one of your positions moves down, another one should be moving up in your favor.
The second is diversification between time frames. Having multiple positions based on different time frames can provide an overall lower volatility in your portfolio. For example, you could be long the daily chart for a swing trade that should last a couple weeks, and you may be short the 60-minute chart because you expect a shot-term pullback. Time diversification is overlooked by many traders.
Third is through position sizing. It's better to have a few smaller positions spread captial over various investments than it is to have one position in only one investment (eggs all in one basket).
Finally, the last and one of the most important is the stop loss. They are commonly referred to as money management stops. They are not used to increase your positions performance. Instead, they are there to protect you from unnecessary loss if the market moves against your position.
Keep in mind when I say protective stop, I don't mean a mental stop (one floating around in your head) I mean a read stop loss order that is live in the market. Risk control should never be an option, it's a must!
In short, risk control will not singlehandedly allow you to beat and profit from the market. But without managing your risk you have no hope of winning in this industry. The key is to stay in the game long enough to start seeing gains and allowing your money to compound over time for above average returns.
Stay tuned for part 4 in this series, Lack Of Self-Discipline!
This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.