Evaluate Personal Risk Tolerance

Risk Tolerance Test Identifies Problems
Risk Tolerance is the area we are going to discuss today. How is your risk tolerance? Would you say that you have a good stable risk tolerance, or is it a big reason you take small losses? Risk Tolerance trips up more Retail Traders than any other emotional aspect of trading.
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Here is a check list of how to evaluate personal Risk Tolerance: 
1. Do you carefully check the Risk to Reward ratio, and only trade stocks with a good ratio?
2. Do you consider the amount of money you have at risk in a trade, and think about how you would feel if you lost that money should the trade go against you?
3. Do you lower your overall market risk by trading more than one or two stocks at a time?
4. Do you use stop losses on every trade, and have those stop losses under appropriate support levels?
5. Do you enter trades only on strong market days? This point is mostly for Swing Traders.

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Here is a Risk Tolerance test. 
If any of these apply then you have a personal Risk Tolerance problem: 
1. If you get stopped out of trades frequently and then watch as the stock moves up, you are setting stops too tightly for the kind of Trading Style you are using.
2. If you panic as a stock retraces and lower the Stop Loss Loss after you are in the trade to avoid getting stopped out, then you are increasing risk rather than lowering it.
3. If you raise the Stop Loss prior to that stock forming a new consolidation which provides support, you will actually increase the risk rather than lessen it. You have typically moved it into the retracement area for the stock and will get stopped out prematurely.
4. If you check profit or loss everyday on a held stock. Position Traders should only be checking their balance once a month. Swing Traders could wait until the end of the month, but can do it weekly. 
5. If you check your stock intraday to see what is happening.
6. If you do not use stop losses, and then watch your stock tumble and are unable to exit.

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The simplest and easiest way to improve your risk tolerance is to continually paper trade on a Simulator even after you are in the market and trading live. Certainly most beginners do not paper trade sufficiently before they jump into the market. They allow emotion to cloud their better judgment and let greed overwhelm their decisions. I can definitely say that the stock market is the only business where normally calm, intelligent, and wise people do really greedy things that end up being foolish and risky.
Our society in the U.S. is geared towards instant gratification and success, which makes retail traders their own worst enemy. Retail Traders sabotage their own efforts and skills by panicking while holding a stock, and deviating from their original plan. Many are fixated on “beating the market” which is just an emotionally charged notion. The only people who need to worry about beating the market are funds managers who must perform quarter to quarter, or get fired. 
Retail Traders have one thing to compete against and that is their own emotions, which causes them to make poor decisions. Competing against the market, funds managers, or other traders is a complete waste of time and energy. You must compete against your own prior history to improve results, and ignore what is going on with everyone else.

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Summary
Emotional control comes from having a sound plan, sticking with it, and not changing it because the market has moved on a whim. If you create a trading style which is a plan of attack for the market, if you set out your strategies and use the correct ones for the appropriate Market Conditions, if you only trade stocks that have a risk factor you can live with, and if you use stop losses appropriately you will be successful. Problems occur somewhere in all of this, when retail traders miss a step and deviate from the plan.

Greed is a tough emotion to control, because it is insidious and hard to identify in ourselves. Fear is easy to identify and much easier to control and harness. A certain amount of fear is necessary and good in the market, because it keeps Retail Traders from doing really risky trades. However fear that dominates the daily emotional energy of a Retail Trader creates constant losses.
Think about this and study your prior stocks. If your stocks performed well after you were stopped out, then there is a risk problem.
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Trade Wisely,
Martha Stokes CMT

TechniTrader

Chartered Market Technician
Instructor and Developer of TechniTrader® Stock and Option Courses
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