As you work toward developing the mindset of a successful trader, you will want to become aware of the difference between business and trading risks and how each of centralex them can affect your long-term profitability as a trader. This article will provide examples of each type of risk that you might encounter in your trading activities, so that you can be aware of these potential trading pitfalls in advance in order to better avoid them.
The first primary type of risk you need to be aware of when developing an optimal trading mindset is business risk. This is the risk that your trading business will not have adequate funds to meet its expenses. Business risk is often ignored by novice traders who are sometimes more focused on making pips than on the bigger picture of what it takes to stay in business as a trader over the long term.
For traders, business risk commonly arises from financial risk, which is linked to the size and stability of any outstanding debt you might be servicing in order to remain in business as a trader. Business risk can also derive from economic risk, which is based on how the overall economic and regulatory climate affects your trading business. Examples of specific business risks that traders sometimes face that fall into in each of these two basic categories appear below.
A. Financial Risks:
Business risks to your trading enterprise might include the following financial risks:
(1) You lose more money trading than you can afford to which then forces you to stop trading.
(2) Having an unhappy boss, spouse or business partner who withdraws their support due to trading taking up too much of your time and attention without providing good financial results.
(3) Insufficient trading returns resulting in the withdrawal of funding from an investor in your trading business.
(4) Margin calls due to adverse market moves that exceed your ability to pay them.
(5) Interest charges on your trading loans that exceed what you can comfortably continue to service.
B. Economic Risks:
Business risk can also cover the following economic risks:
(1) The market becomes unavailable due to new regulation that excludes you.
(2) Market sizes, spreads or commissions become too unattractive for you to continue to participate in trading economically.
(3) Failure to procure the items that you need to be successful and competitive as a trader due to lack of funds, knowledge or experience. These essential items might include trading execution, charting and risk management systems, access to news wires, trading and money management education, etc.
(4) Changes in the tax code that are unfavorable to your trading business.
The second primary type of risk that traders pursuing a constructive trading mindset need to keep in mind is known as trading risk. This can be considered the risk of incurring a substantial trading loss or even perhaps a prolonged failure to grow your trading portfolio’s value. Like business risk, trading risk can also be broken down into two secondary categories. In the case of trading risk, these risks are either market-related risks or are risks not strictly related to market conditions.
A. Market-Related Risks:
Any market-related risk that affects all traders and which is tied to the overall economic system and market conditions is included in this category. Trading risks of this type that involve market risk might include:
(1) Incorrect market view resulting in a trading position being stopped out at a loss.
(2) Loss of liquidity resulting in the widening of dealing spreads and the resulting ineffectiveness of many short-term trading strategies.
(3) Excessive market volatility causing the execution of stop-loss orders (with or without order level slippage) even though the trade would have otherwise been profitable.
B. Risks Unrelated to Market Conditions:
This category includes any risk that is not market-related, including especially those risks arising from trader or trade plan errors. Trading risks of this second type are not strictly related to market movements and can include the following:
(1) Multiple consecutive losing transactions resulting in too high a portfolio value drawdown for the trader to stomach.
(2) Overtrading and losing money due to spreads/commissions.
(3) Loss of discipline in following trade plan resulting in excessive losses.
(4) Analysis paralysis. This is a lack of decisiveness or fear of losing money that results in a failure to pull the trigger on a trade and the consequent opportunity loss incurred.
(5) Lack of diversification in your currency trading portfolio and strategies which increases susceptibility to shocks. (6) Failure to leave a protective stop-loss or take-profit order.
(7) Failure to execute a necessary transaction.
(8) Incorrectly executing or recording a transaction.
(9) Forgetting that a transaction was executed.
(10) Inappropriate position sizing resulting in too much or too little risk taken.
(11) Faulty risk/reward analysis, including regularly executing transactions with a low risk/reward ratio.
(12) Excessive greed resulting in failure to take profits appropriately. Sometimes, such initially profitable trades are even closed out at a loss.
Managing Business and Trading Risks Successfully:
While many traders routinely analyze each position they take for its risk/reward ratio, far fewer traders take the time to perform a detailed risk/reward analysis of their trading business. As a result, they may unwittingly enter into a business situation with a poor chance of long-term success.
The mindset of the successful trader will need to be aware of all of the potential risks to their trading business. They will also need to manage those risks efficiently and economically to ensure their trading business’s long-term survival and profitability. Certainly, keeping any business debt servicing manageable and any investors (including yourself and your spouse) happy will be paramount. Next, upholding a strong commitment to using sound money management principles, maintaining strict trading discipline and keeping good records will put your trading business firmly on the right foot.
Finally, creating a trading business plan in which you consider and address all foreseeable risk situations is a good idea to get your trading business started on the right foot. At the very least, going through this process will help you understand your business as a trader better, and it will also allow you to get feedback from other traders.