You’d have to be from Mars not to know that Chinese stocks have been on a wild ride lately. After a strong rally that morphed into a speculative bubble the inevitable pop saw the market crash around 33% at one point.
Leaving aside the aggressive actions of central authorities to stop the crash in prices the fall stopped almost exactly where technical traders, who use fibonacci analysis, might expect the market to stop falling.
That’s the key lesson of markets that new traders need to understand and experienced traders need to remember. Some patterns just keep repeating through markets, whether they are forex, stocks, commodities or bonds. It’s the repetition of these patterns, and the knowledge of them, that can help traders identify profitable trends and trades.
But the crash in Chinese stocks, and a lesson now learnt by many traders who were blinded by the rally, highlights one of the fundamental rules of trading. You’re on a loser if you don’t have solid risk management rules as part of your trading.
That’s because losing trades, or trades that reverse, are as much a part of long term trading success as outright winning trades.
It’s just a natural by-product of undertaking trades and the low probability of every trade running straight up, if you are long, or down, if you are short, to your profit target.
How you handle your losers and the types of reversals we saw in Shanghai stocks, and how you handle your winners, are some of the key factors to long term sustainable success and the cornerstones of trader risk management.
To succeed as a trader, the size of your potential losses needs to make sense compared to the original profit potential on each new position. Traders need to have established a stop/loss position at the time the trade is entered.
The reason for this is that traders who do not have a disciplined approach find they are often fighting themselves and what behavioural psychologists call “loss aversion”.
Nobel Laureate Daniel Kahneman and his colleague Amos Tversky first proposed the theory of loss aversion in 1979. They said that for most people “losses loom larger than corresponding gains”.
In a practical sense what that means for traders is that without disciplined risk management they will tend to cut their profits short and let their losses run. This is the opposite of what they should do to become successful in the long run.
To help traders better understand what they need to know Business Insider teamed up with CMC Markets to produce “The Trader’s Handbook”, a guide to modern markets. The fourth chapter in the book covers looks at the issues highlighted by the stock market crash in China and looks at the simple rules of a robust risk management system . It’s written to be accessible to people ranging from the simply curious to those who have some experience in markets and are looking to broaden their expertise and knowledge.
The book also covers:
- The key markets and how they’re traded
- The basics of trading
- How to read chart patterns
- Risk management
- The economic data points followed by traders
Register your details below and you’ll get a link to the eBook – it’s that simple. We hope you enjoy it.
The book provides general information only and does not take into account your objectives, financial situation or needs. It is important for you to consider these matters before making any trading or investment decisions. We recommend you seek independent advice and ensure you fully understand the risks before trading.
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