Your Personal Circuit Breakers

One of the most important lessons to learn as a trader is when to stay out of the market. If either you or the market strays too far from normal, it’s time to pull the plug. Exchanges have circuit breakers and so should you.[1]

Having stop-loss orders in place every time you enter a trade should go without saying, but there is more to risk management than position sizing and stop placement. Your edge exists only in conditions similar to those in which you developed it. If you can’t objectively identify what those conditions are, you will at some point be placing trades where you have no edge at all. No matter how obvious this sounds, don’t assume you’ve already sorted it out. Make a list of the conditions in which you have an edge, to prove to yourself you know them. If those conditions aren’t present, stay out. No excuses. Go to Vegas if you want to roll the dice.

In addition to keeping you out of unfavorable markets, personal circuit breakers must also address the single biggest danger to your account: You. Markets have six standard deviation moves only rarely; individuals often do. A risk management plan that doesn’t include the events in your life and your mental state is a plan to fail. Divorce, death in the family, illness, accidents, legal troubles, fatigue, disinterest, burnout, your losses and gains, extreme market volatility, and even how wobbly your chair is (see here) can alter your judgment and ability to appropriately respond to the stresses of trading. No one can handle an unlimited amount of stress. A single, small event may be all it takes to put you over your limit to the point where trading would be a mistake. Make assessing your mental state a part of your daily routine. Know and respect your limits.

If you’re often the last to know when you’re losing it, pay more attention to the reactions of those around you. Rather than arguing about whether you’re acting like a crabby two-year old, or whether you’re in a bad mood all the time, recognize those reactions as a sign that your circuit breakers have been triggered and it’s time for a break. Being taken out by your circuit breakers can be hard to stomach, but returning refreshed with a new perspective is often when performance breakthroughs are made.
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[1] Except your circuit breakers should be meaningful, effective, and unbiased.

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One thought on “Your Personal Circuit Breakers

  1. Pingback: Sunday links: redundancy rules | Abnormal Returns

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