Effective Strategies for Developing a Trading Process That Minimizes Losses

Bob Iaccino, Chief Market Strategist and Co-Founder of Path Trading Partners, joins us live every Thursday from 11am ET, as our risk management educator.

With 30 years' experience working as an active investor in equities, commodities, futures and FX there are few better to talk on the subject of risk management.

Bob has developed a method for breaking down his key fundamentals of risk management, in a way that he thinks retail traders can understand and use to get actionable insights to bring into their own trading.

Below are some excerpts of Bob’s thoughts from a recent live session.

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What are some effective strategies for developing a trading process that minimize losses?

A lot of people answer this question by scalping - by being in the market for short periods of time and that does work. However, I want to stress to everybody that scalping isn't necessarily as low risk as it used to be.

The reason I say that is because the shorter time frame, shorter spreads, larger position size that you're in the market, you expose yourself to high frequency traders.

Events happen that cause high frequency systems and traders and algorithms to blow out positions and when you're in very tight markets, you're exposed to that. Markets are very, very large.

My first piece of advice is to always expand the ranges you're looking for and shrink your position size.

If I have one share on and I have a $1.00 loss, that's very tight. If I have 100 shares on and I have a $1.00 loss, that's $100 risk. It’s the same amount of risk.

If I have 10 shares on and I have a $10 wide move risk, it's the same loss, therefore, it's essentially the same trade.

If you have 100 shares on and you're looking to lose a dollar or make a dollar, you're either going to lose a dollar or make $100. In my case, if I have 10 shares of $10 risk and $10 reward, it's the exact same trade, except you're not at risk.

With moves that happen like this, they're so fast that you're unable to respond to them or predict them.

Why is position sizing so crucial to minimizing losses?

Position sizing is the number one thing. When traders talk about developing a strategy that minimizes losses, position sizing should be the first thing that is focused on. Then traders have to understand the difference between risk capital and the money in their account. What do I mean by that?

If you're trading stocks and Reg. T margin is available to you, and you want to trade $1,000, you only have to put $500 in the account.

$500 is what's in your account. $1,000 is your risk capital. These are two different things.

Risk capital is the total amount of capital you're willing to commit to this process, to this education, to this method.

If you say - “I'm going to put $500 in my account, but I've got another $4,500 on the side that if I lose, I'll put it in there”, your risk capital is $5,000, not $500.

That is a critical difference for when you're developing a process that minimizes losses because you don't want to compare it to the amount in your account. You want to compare it to the total amount you've committed to your learning and your process.

Secondly, I would say set stop loss orders and determine the maximum amount you're willing to lose on a trade. Many people take that as saying - “I only want to lose $100. I entered at 200, so my stop loss is at 100.” No, that's incorrect. Based on the research you've done on your entry method; you should decide on a risk per trade and reverse engineer it into a percentage number.

What do I mean by that? You should be looking at percentages, not dollars in terms of risk and gain.

How do you stick to a percentage-based process?

If you're looking at percentages, suddenly, it's easy to not worry about how much you're down. Because, if I tell you you're going to be down $1,000, thats probably going to stress you out, but if I tell you you're going to be down 1%, it sounds completely different.

You're not looking at it at a dollar amount, you're looking as it at a percentage. Percentages are much easier to manage than dollars are because when you're seeing dollars you're relating them to expenses you have in your life.

You might say - “Wow, I'm down $500. That's almost 25% of my rent or that's my whole car payment. That's a lot of money.” But if you've committed to $50,000 to this process and you're down $500, $500 divided by 50,000 is 1%. You're looking at a 1% loss.

That's the way you stick to your process.

Here’s an example of reverse engineering: If you have $5,000 in risk capital – this is not the money in your account, it's the total money you're willing to risk. Before you say - you know “this experiment failed, I'm not doing it anymore. $5,000 in risk capital, I'm only comfortable losing $150 on any trade.” $150.00 divided by $3,000 dollars equals .03 or 3%. That's your risk per trade. You're reverse engineering it.

You start with the dollar amount that you know won't make you vomit and then you reverse engineer it into a percentage. You stop looking at the dollars after that.

As your account grows and as your risk capital grows, you risk more during winning streaks and you risk less during losing streaks in dollars, but it's the same percentage all the time.

Disclaimer: Live Sessions (hereafter referred to as the “Content”) are produced by TradeZero. The Content may include the views and opinions of TradeZero and a third-party participant, Bob Iaccino. Bob Iaccino is compensated by TradeZero for participating in the Content. Mr. Iaccino’s trading experiences and accomplishments are unique, and your trading results may vary substantially from his. TradeZero is not responsible for and neither affirms nor endorses any of Mr. Iaccino’s views or opinions expressed in the Content. TradeZero makes no representations or warranties with respect to the accuracy of the Content or information available through any referenced or linked third party sites. The Content has been made available for informational and educational purposes only and should not be considered trading or investment advice or a recommendation as to any security.

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