Yesterday I posted my watch list with a note that I was risking only .25%. That post led to the following question:
It’s tough to answer this question in 140 characters. First you must have the context of what I meant by the market lacking direction. Below are weekly and monthly charts of the S&P 500. They show that the S&P has lost the 50 day moving average and is struggling to regain the 20 day moving average. As a swing trader with a 2-10 time horizon for trades, this shows me a lack of direction in the overall market.
It has been my experience that this type of market environment is difficult for swing trading. What do I mean by this? My results have been poor when I see the market trading below the 50 day and struggling at the 20 day.
Since I cannot predict what the market will do next (for all I know we will rally above the 50 day tomorrow) all I can do is manage risk based on the current market conditions. How do I do this? by risking no more than 1/4% of my overall portfolio balance on any trade that triggers. Here is an example:
On a $100,000 portfolio, 1/4% risk = $250 – this means I will risk a loss of no more than $250 on any position until the market finds a direction.
As a trader, it’s important to know how the current market environment affects my trading. This way, I can protect myself when conditions are not optimal for my strategy.
By reducing my risk I protect myself from big losses and, since I cannot predict what the market will do next, I am still in the game if the market turns in my favor.
For more on managing risk, look here.