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William O’Neil said that, “The whole secret to winning the stock market is to lose the least amount possible when you’re not right.”
A successful trading system hence must be able to reduce losses in order to preserve the capital as much as possible. Losing 10% of your capital will need 11.1% to bring you back to your original capital. The problem about trading is that you can never be 100% right, hence, it is very important to minimize the loss when you are wrong.
There are 2 critical elements that must be present in every trading system in order to minimize risks and losses. Not in the order of merit, the first element is position sizing. Position sizing is about allocating the amount of trading capital to a counter. There must be a rule that states the maximum amount of capital the trader can place in one trade. This is to prevent the trader from overexposing himself to a particular stock and result in a heavy loss when this particular stock pick is wrong. Read more...