A Risk Tolerance Test for All Traders

Risk Tolerance trips up more traders than any other emotional aspect of trading stocks, or any other asset class. How is your risk tolerance? Would you say that you have a good stable risk tolerance? Or is it the main reason you take small gains or losses?

If you need help evaluating your risk tolerance, take this Risk Tolerance Test. If any of these apply, then there is a problem you need to address:

1. Do you get stopped out of trades and then watch as the stock moves up? This is caused by setting stops too tightly for the kind of trading style being used.
   
2. Do you panic as the stock retraces and lower the stop loss to avoid getting stopped out? This actually increases risk rather than lowering it.
   
3. Do you raise your stop loss before the stock forms a new consolidation for support? This also increases risk rather than lessening it. There is higher risk that you will get stopped out prematurely.
   
4. Do you check profit or loss everyday on your held stocks? Position traders should only be checking their balance once a month. Swing traders could wait for the end of the month but can do it weekly.
   
5. Are you a swing trader who checks your positions intraday to see what is happening? This runs the risk of reacting prematurely to intraday volatility that eventually evens out.
   
6. Have you given up on using stop losses because "they don't work"? You probably just need to learn a better method for placing stop losses.
   
7. Do you hold and hold with no stop loss, watching a stock tumble, unable to exit and ultimately exiting too late or "holding long term" instead? This is a chronic problem among retail traders that indicates the lack of a complete trading plan, one that provides a plan for when your holdings go against your intent.
   

To keep your risk tolerance in check try adding these simple steps to your trade analysis:

• Carefully check the Risk to Reward ratio of your picks, and only trade stocks with a good probability for profit vs. loss.
  
• Consider the amount of money at risk in each trade. Think about how you would feel if you lost that money should the trade go against you. Add this parameter to your trading rules.
  
• Lower overall market risk by trading more than one or two stocks at a time. Spread your capital outlay over a few picks rather than putting it all on one trade.
  
• Use stop losses on every trade. Place stops under the appropriate support levels for the chart patterns and your intent.
  
• If you are a Swing Trader, it is important to enter trades only on strong market days. Not every flat day is a good day to swing trade. You'll keep more of your profits over time if you wait for ideal days and picks.
  

The simplest way to improve risk tolerance is to continually paper trade on a Simulator even after you've started trading live. Most beginners do not practice executing their trading plan sufficiently before jumping into the market. They allow emotion to cloud better judgment and let greed overwhelm decisions. Trading is the only business where normally calm, intelligent, and wise people do really greedy things that end up being foolish and risky. And it all comes down to the emotions that come with money, especially fear, greed and pride.

Traders have one thing to compete against and that is their own emotions, which can cause poor decisions. My best advice for all traders is this: compete against your own prior trading history to improve results, and ignore what is going on with everyone else.

Summary:
Emotional control comes from having a sound plan, sticking with it, and not changing it because the market has moved on a whim or some guy on social just made a lot of money. Create your trading style, which is a plan of attack for the market. Set out your strategies and use the correct ones for the current Market Condition. Only trade stocks that have a risk factor you can live with. Use stop losses appropriately, and you will be successful. Problems occur somewhere in all of this, when traders miss a step and deviate from the plan.

When you feel emotions getting out of hand, controlling your trading decisions, consider the above checklists for help evaluating and adjusting your mindset. Greed is a tough emotion to control, because it is insidious and hard to identify in ourselves. Fear is easy to identify and much easier to control or harness. A certain amount of fear is necessary and good in the market, because it keeps individuals from taking too much risk. However, fear that dominates daily emotional energy only creates constant losses. Think about this and study prior trades. If they performed well after being stopped out, then there is a risk problem to address in your trading plan.