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The Risk of Trading: Mastering the Most Important Element in Financial Speculation by Michael Toma

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RISK MANAGEMENT RULES FOR THE TRADER

First is to wholeheartedly accept market variance. It is a powerful force in the markets and not only must it be accepted but also understood. Variance will test your confidence in a particular setup or even as a trader. Often there will be times where you will have multiple losing sessions during times of peak execution and plan compliance. I can offer you an opportunity to pay you $2.00 every time a coin lands on tails and you pay me $1.00 every time the coin lands on heads. Let's say we take 20 sessions with 10 flips of the coin. Most would jump at the chance, especially if the contest included as many flips of the coin as I could tolerate. One sure thing is that I am confident I will win at least a few of those sessions, even though statistically the odds are clearly in your favor to have a better dollar win outcome. The markets work in the same way. If we started this contest and after four sessions of 10 coin flips I was actually ahead, would you give up and complain that the “system” doesn't work? Of course you wouldn’t. Now if you only brought $20 to the game, you would be in dire trouble. In fact, you would be a loser in a game with an obvious edge on your side. It can and does happen in the markets every day. New traders with a minimum bankroll cannot overcome the Keynesian quote mentioned earlier. To overcome this variance, one must overcome the short-term fluctuations of the markets. It must be overcome not only from a trade execution ...

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