Forex Trading Strategies – Appreciating Asymmetrical Risk
Every time I am at our office downtown and have to rush to NBC studios at 30 Rock in midtown I am faced with a difficult choice -- local or express? The number 1 local gets me to Broadway and 50th just a minute’s walk away from the studio, but it makes multiple stops on the way. The 2 or 3 express makes only four stops but drops me off at Times Square which is at least 8 city blocks away from the studio.
Despite the longer walk, I almost always choose the express because it guarantees to get me from downtown to midtown in less than 15 minutes. Once I am in vicinity I know I can make it to the studio on time. The net result is that in more that five years of doing TV I have never missed an on air interview due to travel delays.
The CNBC studio dilemma is a perfect example of asymmetrical risk. Although the convenience of the local is attractive the risk of delay is so great that I rarely worth taking. I usually endure the eight block walk through snow, sleet and rain to ensure that I am always on time.
As traders we face asymmetrically risk every single day. How many times do we find ourselves 50%, 60%, 70% towards our profit target only to see price reverse, profits disappear and our stops get hit? If you are short term trader you likely face this problem at least a few times each week.
The conventional wisdom is that you should always stick to you stops and targets, otherwise you destroy your risk and reward ratios and pay for it over the long run. That view has a lot of merit, but like all rules in life it is not absolute. The longer I trade the more I realize that its often futile to impose our artificial rules onto the market which is a constantly changing system that rarely complies with our fixed expectations of profit.
Most traders this that the object of trading is to make money, but the actual goal is to lose as little as possible. Not losing money is much more important than focusing on making it. Let’s take a look at a trade with a 20 point target and 20 point stop. It goes in your direction by 19 points and then reverses to stop you out.
How much did you lose?
You actually lost 39 points. That what you will need to make just to get back to the point before the position moved against you. That’s why the longer I trade the more I believe in the “vicinity” theory of trading. If I am 70% or more towards my target and price stops moving my way, I will often close out the trade. Sometimes you have to take what you can get and it’s amazing how much you can gain by just “not losing” as often as possible.