The Art Of The Risk Free Trade

The Risk Free Trade Can Make You A WinnerThe Art Of The Risk Free Trade

Many people ask me if there’s a way to invest in shares without taking any risk.  Usually I tell them if you can’t afford to risk any money then you really shouldn’t be trading.  With all the things going against you in trading – brokerage, price slippage, institutional investors, bad advice or tipsters vying for your attention, it’s no wonder most traders fail.  In fact, I used to say the only real risk free way to earn a living is through a day job.

Sure, you could use options, and buy a Put or Call option as a safeguard – but options still cost money to buy, so your trade really isn’t “risk free”. 

No, there is a far better way – a simpler way, a more cost effective way.  And it’s something that less than ½ a percent of traders or investors will focus on.  Despite this, the very top percentage of traders and money makers are the ones using this strategy.  What is it?  Trade Management.

The Secret Of Trade Management

The idea behind trade management is to get our stop loss to the break even point as soon as humanly possible.  In other words, we start with our regular stop loss – our initial safeguard against loss (for more information on stop losses, click here), and as price moves in our favor, we move the stop loss up with it, until it is soon at our entry point – giving us effectively $0 loss (not including brokerage of course) and a risk free trade.  Let me give you an example:

We buy a share at $20.  Deciding that we want to use a percentage stop loss, and deciding on 10% below our purchase price, we set our stop at $18.  Within a few weeks, the price shoots up from $20 to $23.  We move our stop loss up to $20 and eliminate all of our price risk!

How Do We Know When To Move Our Stop Loss?

Probably the best and easiest way to get our stop loss to break even is in two parts.

  • When price moves up by the same amount as our risk (1 x our risk past our entry point), we move our stop to half way (by that I mean halfway between our initial stop and our entry point).
  • Once price moves 2x our initial risk past our entry point, we move our stop to breakeven.

As always, I find an example really helps:  If we buy our share at $10, and set our stop loss at $9, our initial risk is $1.  So, when price moves up by $1 (or 1 x our risk), we move our stop loss to halfway – $9.50.  When price moves up $2 (or 2 x our risk) we move our stop loss to break even, $10.

Why do we do it in two parts?

This gives our stock some “wiggle room”.  It took me a while to figure this out, but I will share with you one secret I have learned over years of trading.  Good trends take time to grow.  Sure some will take off straight away, but with most you need to give them a little room – nurture them, and as soon as they’re ready they will take off.  It’s when this happens we are ready to get our stop to break even for our theoretical risk free trade.

The other reason I do it in two parts is that often price will retrace back into our entry point once before traveling on (the reason for this is the larger investors selling stock – trying to shake out the weak hands so they can snap up the stock at an even cheaper price before it shoots up).  If price retraces back twice into our entry point however, this is a bad sign, and a good reason to have our stop loss up at halfway ready to exit.  

So while any investing carries with it an element of risk, mastering the art of the risk free trade is one of those skills that will serve you for a lifetime of investing – while you watch other traders fall by the wayside.  Hey, it leaves more money for you and I – and that makes me happy.

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June 18, 2009  Tags:   Posted in: Free Trading Course Lesson Backlog

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