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RISK MANAGEMENT:IDENTIFYING ANDMANAGING THE KEY AREASOF RISK CONTROL
  
 
  
Now that I have taught you my best Fibonacci trading strategies, I want to do every-thing I can to help you get the most benefit from them.
For each of the trading strategies I have taught you in this book, I have providedyou with trade management techniques to keep potential losses under control. Butstrategy and money management are only two ingredients that are necessary forlong-term success in trading the financial markets.
No matter how well you understand the step-by-step process of applying thesestrategies and managing the trades, this knowledge will only benefit you if youhave the discipline to execute the strategies properly. That is what most people havethe greatest degree of difficulty with.
WHY IS PROPER EXECUTION SO DIFFICULT?
I have seen many people come into this business who have been successful in otherwalks of life, like doctors, engineers, attorneys, etc. The success these people haveachieved in their previous careers was largely attributed to their ability to perfecttheir skills. Unfortunately, they quickly discover that there is no method of trading
that allows you to become 100% accurate or “perfect.” This simple fact drives peo-ple out of this business.
When someone has a string of two or three losses, they feel defeated and eitherblame the losses on themselves or redirect that feeling of failure to the system beingused. Once this happens, they start to second-guess their strategy or change therules. Soon their losses pile up and the pain becomes so intolerable that they giveup.
I maintain that the weakness that people have is that they direct their innate desirefor perfection to the wrong aspects of trading.
° The common tendency is to focus on perfect performance in the form of ahigh percentage of winning to losing trades.
Fortunately, I believe there is a way to furn that weakness into a strength. To become asuccessful trader, you can still aim for perfection. Here’s how:
° Rather than focusing on perfect outcomes for every trade, you must insteadfocus on perfect execution of every trade.
That is, when you have a viable trading method, you must be completely committedto executing its prescribed steps together with trade management, perfectly. Only by
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repeating this process over and over again and never deviating from it, do you havea solid foundation for success.
This is not easy to do, at least initially.
The reason is that the process of trading tends to stir up deep emotions that seri-ously wreak havoc to one’s decision-making ability. This where psychology comesinto play.
In order to trade successfully, you must have a framework for executing each of therules of your trading strategy that does not allow your emotions to impact theprocess. Controlling your emotions is a broad topic that I am not an expert on. But Jknow from first-hand experience that it is critical to executing each trade properly.
In terms of learning how to control your emotions while trading, I’ll leave that tothe experts.
I recommend you read Trading In The Zone by Mark Douglas. It is a requirement foranyone that I mentor in trading. The other book that I have found extremely valu-able in this area is The Tao Of Trading by Robert Koppel.
Now, we have covered strategy, execution, money management and psychology.Restating these factors in a different way, the formula for success in trading is:
Strategy + Execution + Money Management + Proper Psychology =Trading Success
I could write an entire book on the topic of this formula. But since that is not themain purpose of this book, I will instead give you the knowledge that I consider tobe the starting point for trading success.
CONTROLLING RISK EXPOSURE
If you want to become a successful trader, the best starting point is to master yourability to control risk. With every strategy that I have taught you in this book, I haveincluded money management rules. All of the examples I took you through, employthe use of stops and trailing stops. But managing individual trades is only oneaspect of risk control. I have found that there are many other risk variables, and themore awareness and control that you have over them, the better your tradingperformance will be.
I have built a checklist to walk through every night as I prepare for the next tradingday.
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- Directional Exposure:
How many long trades and how many short trades do you have inplay right now? Are you overweighted in a certain direction based onthe current position of the overall market?
. Sector Exposure:
Of the positions you have, is there any one sector in which you areoverweighted? If you have three trades in your account and they areall long semiconductor stocks, you are not doing a good job of control-ling risk.
. Position Size:
Are you only risking a maximum of 2% to 3% of your equity in onetrade? Be sure to think and plan this one through very carefully. 2% to3% works for my account size. However, a different level of risk pertrade may be more appropriate for you.
. News Exposure:
Are you avoiding being exposed to news (such as earnings announce-ments) that may have negative or unpredictable effects on any tradethat you are in?
. Pattern Exposure:
Are you overexposed to one particular trading pattern? Let me explainthis further. What happens a few times a year is that the entire marketforms the same pattern. You look at the indices and, for example, theyare forming a Bullish Gartley TSP pattern on a daily chart. Well, as I domy nightly homework, I find 30 stocks with Bullish Gartleys. Howmany do I take? My answer to this is one. In situations like this wherethe entire market is setting up with the same pattern, I trade a marketproxy like the ETFs or index futures. Inexperienced traders would seethese patterns as tons of Opportunity and lots of profit potential, andconsistently lose. The trader who consistently wins sees this as a majorrisk. The winning trader thinks, “What if this pattern fails and I’m longall these daily Bullish Gartley patterns?” The pattern can be a high per-centage trade, but if the market breaks down and the pattern fails onthe index level, guess what? It is highly likely that all 30 of those otherpatterns fail as well. In reality that is only one failed pattern. Bottomline: Be smart in allocating among various types of patterns.
 
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6. Time Frame Exposure:
I get asked this question often as well, “What time frame do you tradein?” Well, the answer to that is monthly, weekly, daily, 60-minute, and30-minute charts. Personally, I think it is extremely unhealthy to haveall trades based on one time frame. Mix it up, and have longer termtrades and shorter-term trades in the account. This is a great diversifierand personally it keeps me sharp and aware of what the markets arelooking like on these different time frames. Analyzing multiple timeframes of a security is like watching a story unfold or even watching awell-choreographed dance. These different time frames are interrelated; and have an action/reaction relationship.
7. Total Portfolio Risk:
This is straight forward. If all your positions were stopped out today,how much of a hit would it be to your account? If your answer is morethan 20%-25%, I would caution you to rethink the total portfolio riskexposure. Bad things happen to extremely talented traders. This issomething you can control!
Do not get me wrong here. The goal of trading is to attain high absolute positive re-turns annually (at least that’s my goal). To do this and attack it with intensity, youmust first identify and manage risk. Once it is identified and boundaries are inplace, be aggressive, take charge and expect to succeed.
I will leave you with a few of my favorite “mental” quotes as they have significantmeaning to our business of trading as well as life:
1. “Your mind is a sacred enclosure into which nothing harmful can enter ex-cept by your permission.” - Ralph Waldo Emerson
2. “The less I think, the better I will do.” - David Lansburgh
3. “... Being in control of the mind means that literally anything that happenscan be a source of joy .. .” - Mihaly Csikszentmihalyi
4. “... exercise unrelenting discipline over your thought patterns. Cultivateonly productive attitudes . . . You are the product of everything you put intoyour body and mind.” ~ I Ching
5. “The greatest efforts . . . come when the mind is as still as a glass lake.” ~Timothy Gallway
6. “Let the market, not your ego, make the decisions.” — Ed Toppel
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7. “Positive emotional state leads to optimum trading performance.” — RobertKoppel
8. And here are my favorite quotes from Mark Douglas:
° “Trying to avoid something that is unavoidable will have disastrous ef-fects on your ability to trade successfully.”
“The best traders aren’t afraid.”
“Ninety-Five percent of the trading errors . . . stem from your attitudesabout being wrong, losing money, missing out, and leaving money onthe table.”
e “... there are no limits to the market's behavior.”
“Market analysis is not the path to consistent results.”
“Even though the outcome of each individual pattern is random, theoutcome of a series of patterns is consistent (statistically reliable). This isa paradox, but one that is easily resolved with a disciplined, organized,and consistent approach.”
“Attitude produces better overall results than analysis or technique.”
“Losing and being wrong are inevitable realities of trading.”
“It does not do you any good to take the risk of putting on a trade ifyou are afraid of the consequences, because your fears will act on yourperception of information and your behavior in a way that will causeyou to create the very experience you fear the most, the one you are try-ing to avoid.”
“Each trade is simply an edge with a probable outcome, and Statisticallyindependent of every other trade. If you believe otherwise, then I cansee why you're afraid; but I can assure you that your fears are com-pletely unfounded.”
“One of your basic objectives as a trader is to Perceive the opportunitiesavailable, not the threat of pain.”
“If you asked me to distill trading down to its simplest form, I wouldsay that it is a pattern recognition numbers game. We use market analy-sis to identify the patterns, define risk, and determine when to takeprofits. The trade either works or it doesn’t. In any case, we move on tothe next trade. It’s that simple, but it’s certainly not easy. In fact, tradingis probably the hardest thing you'll ever attempt to be successful at.”
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CLOSING THOUGHTS
I hope you have enjoyed reading and learning about the many facets of trading withFibonacci. It was my goal to give you an in-depth exposure to Fibonacci time andprice analysis and to enable you to calculate Support and Resistance FibZones. Withthat base knowledge of creating FibZones, it was my goal to equip you withhigh-probability strategies using these FibZones. Finally, I wanted to stress the partof trading that doesn’t involve strategy. So much of trading success has nothing todo with strategy and all to do with money management and mental approach.Finally, I believe a trader can walk away with one or two of these strategies andwhen incorporated into “The Formula” for success, will achieve solid results.
I have officially passed on to you an “edge” in the market place. Now it’s up to youto decide what to do with it.
Derrik Hobbs
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