Risk Exposure and Consequence Mitigation

What is job #1?

Manage your risk, manage your risk, manage your risk.
Or, that’s what they say.

This is true but, it’s also a bit lacking. I think it reduces the general concept of “not getting killed” to too small a thing. I for one am not here to “manage my risk”. I want my risk to be as high as possible.

Risk is how we get paid. That is a fact. So that means that we need a more robust method of thinking about risk than simple to manage it or reduce it. Let’s introduce a variable “consequence” into the equation and see what we get.

Two issues with risk control

Issue #1:
Reward is tied to risk. No way around this. You can build a high R:R strategy and should (only way to go imo) but, you still have linked Risk : Reward metrics. For many, this is fine. For me, it is not. I am not willing to trade a 2:1 RR system because it does not offer enough edge. Why? Because I am far from perfect. I (you probably as well) can bugger up a 3:1 RR system and trim it down into a 1:1, am I right?

Which leads us to issue number 2.

Issue #2:
It is almost impossible for the human mind to wrap itself around the concept of risk in the aggregate. Meaning, we will (almost always) do anything we can to adjust our execution or system to offer us less risk and thus less reward.

Let me explain.

You put on a trade with 4 contracts.
It goes for you, then comes back. Almost hits your stop. Then, forward again. What happens?

Well, you’ve either added to the trade as it came against you or, if you have good discipline, you are in the same size but considering your current “risk”. The trade has gone against you. You consider this trade to be at high “risk” of stopping you out. What do you do? You de-risk the trade if you are really really good. You take 2 off at BE. “This trade is gonna lose” you say to yourself. “Better lose a bit less, turn down my risk”.

This is a mistake.

Why? It follows the logic of managing your risk. “I reduced my risk when the trade no longer looked good” you might say.

Let’s pretend now that this trade goes on to be the biggest winner of the week. After you close half you position size, your short trade turns out to have nailed a major swing high and price falls off without ever retesting your entry again. Kicking yourself. That is what you should be doing.

You need these wins to pay for all those losers. Trust me. We all know that.

In this example, you’ve reduced consequence by reducing exposure. You’ve also reduced reward by the same. Later, we’re going to talk about how to Mitigate Consequences while keeping Risk Exposure the same. Remember, Risk Exposure is what we want. (why I capitalized it improperly)

Another Example:

Same thing happens. You enter short on a signal. The trade goes against you. You add a bit. Feathering into positions is a fair method ( I do it often). The issue here is that, in the face of perceived risk, you increase consequence. Now, stop out consequences are higher and risk of being wrong is also higher. This is not good. If you’re going to make a mistake, make the first one above, not this one.

Losers average losers.

We all know this. Nothing new here. However, I want to take this risk vs consequence idea and flesh it out into some internal monolog that you can use actively in your trading.

Know what the hell you are doing.

In the face of risk, the mind needs concrete action and behavior expectations.

As I said in a previous post, I am often long LOD or short HOD. Remember, the worst looking trades are my jam. (fade the strong 5 or 15 min bar close is a fav)

How to make bad choices

I have traded with so many conservative “I told you so’s”. Really grinds my gears. There is no money in this. Not on the Naz anyway. You also can’t be a thrill seeking degen either. So, what do you do?

You create a method of excellence for making what seem like “bad choices”.

Mine is simple. I enter a trade. I talk to myself. Here is what I say:

“This trade is high risk. It is also low consequence”

What are the consequences for any trade I have on at any time? This is all I want to know. I don’t care how likely the trade is to work. I don’t care how much I might or might not make. I don’t care if the market is “looking really bullish”. None of that matters in any way to weather or not I will take a trade.

It’s because of this that I don’t believe in managing risk. I want as much RISK as I can get. I mitigate my consequences. I want as much risk as I can have with as little consequence as possible.

If you start thinking this way, it will change how you trade. Most people put on a “safe” trade and then ride it as long as they must in order to be right. Don’t do this.


Let me tell you how to add to a trade.
If you are long and showing a positive PnL… hit the buy button again.
If you are short and showing a positive PnL….. hit the sell button again.

In reality, why is adding harder than this?

It’s harder because “If I add, I am adding to my risk and I don’t want to be over exposed if it turns around”.

This is wrong. Sorry, I don’t mean to be pushy here. It just is.

What you should say instead is: “What are the negative consequences of adding?” Once price moves away from your entry enough and the setup warrants the add, adding is doable without adding to the negative consequence. You may still get stopped out but, well managed and you get stopped out for BE or near. Certainly less than you would have if you had put on this size first and the position went wrong. The payoff? You were able to increase risk exposure in the case that the other side didn’t’ handle their consequences well. Beauty!

When Tom Hoggard talks in his book about “Flipping the Switch”. This is the switch.

Remember, clarity is confidence and confidence in markets is talent.
(so is the ability to think as said by Pencil_Trading, and we need to think and then act our way to confidence.)

To wrap up this idea.

If you are trading at your limit, you will feel fear. You can use rational thinking to override your emotional/ego brain. You can do this in the same way we do as climbers.

I get scared.

4 pitches up on a flat frickin finger crack and my palms are sweating. How do we manage this? We do not consider the “risk”. “What if I fall and die!”. That would be bad. We override the perceived risk with actual consequence. “I am safe in my harness. My knots are tight. My belay is good. We are game on. I am good to go here even though I am emotionally uncomfortable”. (maybe it’s not that robust of a thought but you get it)

We actively work to re-enforce mental stability by seeing the real consequences of our actions.

Now, if at any time the consequences increase to a place that is not tolerable, we pull.

So important. It’s not about risk. It’s about consequences.

So next time you look at a trade that fits your system, instead of asking yourself something subjective like “Is this a good trade?” or “Is this really the best place to buy/sell?”.

Ask yourself another question ” Can I accept the consequences of this trade?” and “How, if I am right, can I increase my risk exposure without increasing my consequences?”.

This is the mental gateway to trading size.

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