Original subtitles

Okay so welcome back to the desk. Uh we're going to move on

now to the next section of the video series having discipline

or risk management. In having discipline one, risk management

one. Uh we're going to be primarily looking at the

principles behind risk management and why we have risk

management in the first place. And it's very very important to

pick up these principles along the way. The the first

principle you're going to pick up is the principle that if

we've been through the whole idea generation process we've

created our fundamental biases through the fundamental data

towards currency pairs and then we've been through the

gatekeeping process and try to time those fundamental ideas

better we now get to a point where we're about to take a

position or we've now started to take positions and we're now

actually looking to risk manage our trades and have an

actionable trading plan now the first principle we're going to

pick up in risk management here is that you need to make an

assumption in trading always. You need to make the assumption

that there's nothing that you know that the market doesn't

already know. That's very important. We're going to pick

that up as we go the basics of risk management and the

principles underpinning as to why we have risk management.

The next principle and underpinning that we need to

understand is actually the psychology behind risk

management and really this is about understanding human

psychology and when understanding human psychology

being able to step outside yourself and be able to

critically analyse weaknesses of humans from a

psychologically from a psychological perspective and

then being able to seek to do the opposite. We're going to

pick up that principle as we go through as well and this

underpins why we have stop losses and targets which we've

mentioned briefly in the video series prior to risk management

but now we're really going to start to understand how to

construct trades and actually how to risk manage trades

properly. Uh we're also in this video going to go back to ATR

and we're going to start using the ATR assessment that we made

earlier on in the video series not only to assess opportunity

but also to assess risk. So, we'll be going on the computer

screen and we're going to be using Euro dollar as an example

so we're now going to be dropping Aussie dollar US

dollar as our example because we've used Aussie dollar US

dollar throughout the video series we've got to the point

where we have a fundamental predisposition or buyers to be

short Aussie dollar US dollar exchange rate we've been

through the gatekeeping process and realize that our timing is

off so we're now going to sit back and wait for opportunities

for Aussie dollar US dollar to short into rally. So that

served as a great example to this point. The assumption

we're going to make here now is that you're actually running

your watch list. You have a whole bunch of ideas on your

watch list and one of the ideas you want to pursue is short

Euro dollar. So now we're going to drop the Aussie dollar US

dollar as an example and use Euro dollar US dollar as an

example as we've got this point it's on our watch list and we

actually want to go ahead and short it. So we're now

deploying capital to this trade. So first of all we're

going to go through all of the basics of risk management in

risk management to having discipline one and then we're

going to move on to more and further risk parameters in risk

management having discipline two and actually look at an

actionable trading plan for an overall portfolio later and

we're also be we'll be looking at further risk parameters that

we can have in our portfolio to become a lot more of an

efficient trader managing risk going forward so let's go over

to the computer screen and start looking at all of the

reasons why we have risk management in the first place

that's a very crucial step to understand because longer term

it means if you pick these things up you'll respect risk

management a lot more and have a lot more discipline than the

average retail trader and we'll also go and have a look at Euro

dollar as an example of how we actually go about looking to

construct a trade deploying capital and looking to manage

the risk on that trade and I'll see you at the end of the

videos at the end of the video for a recap okay so now we're

going to move on to the next section of the overall process

we're going to move on to having discipline and having

risk management processes in place. So before we actually

move on to an example of risk management application to

currency trades. It's really important to understand why we

have these risk management practices in the first place.

Now you have to understand that risk management practices are

not an accident. You know we don't apply risk management to

our portfolios for no reason. They're not processes that

people just dream out of thin air. Uh they have a real

rooting in psychology and in order to really understand risk

management. What we have to first really understand is

trading psychology and getting our trading psychology sharp

and correct. So, as a reminder, where does this fit into the

overall process? Well, our main phase here was our idea

generation phase. This is how we come up with trade ideas

that are to come or to become potential trades as in

potential real positions. Then, we have our gatekeeping process

which is our commitment of traders reports, technical

analysis price action indicators to essentially

cleanse our ideas and have a process to stop ourselves doing

something stupid in terms of deploying capital to our ideas

now if we make the assumption here that we've generated a

whole bunch of ideas that are to become potential trades so a

whole bunch of currency pair ideas and to go long or short

for currency pairs. We've been through the gatekeeping process

and we now think that everything lines up in terms of

our fundamental idea plus our timing to get into the trade.

We're now going to deploy capital and we're going to end

up with a real position in our portfolio in our retail trader

accounts. What we're going to look at here first of all is

the having discipline section where we'll be looking at

trading psychology why we have risk management principles or

risk management practices in place within our trading

accounts and looking at how we actually apply it with some of

the resources that we've had previously in the video series

so the will be having discipline one, risk management

one. Then we're going to move on to applying some sensible

common sense risk management practices to our overall

portfolio and then later we'll be going on to working out our

self-awareness statistics as traders. So in the overall

process this is where risk management or having discipline

fits in. It comes in when we actually have deployed capital

and we have real live positions. Now, in the PTM

video series, we specifically looked at risk management

examples in stocks. So, how you manage the risk of a stock only

portfolio. And the underpinnings or foundations of

why we use risk management are exactly the same in currencies.

However, the application is just slightly different. So, if

you've already accomplished completing the PTM video series

as long as you fully understand those principles that we showed

you in the PTM video series of trading psychology and why we

have it you'll have a very good idea of how to apply this in

currencies anyway but you may choose to skip or skip this

part or complete it in order to just refresh your memory you

know there's no harm in going back and revisiting this area.

Uh in fact, you should always revisit this stuff as as much

as you can. Um if you've not completed the PTM video series,

we'll provide you with the basic underpinnings of trading

psychology and the principles as to why we have risk

management in the first place. But in the PFTM video series,

we're going to apply this only to currencies. If you want to

understand the application of trading psychology for other

asset classes, so stock sectors so sector ETFs in the stock

market indices and for real life examples on how trading

psychology applies to all areas of your life so career business

relationships family etcetera this is only covered in the PTM

video series and it's not going to be covered in the PFTM

video series so in the PT video series will give you a much

wider application of risk management but in the PFTM

video series we're going to be only concentrating on

currencies but having exactly the same principles underlying

the theory behind trading psychology and in the PTM video

series the overall application has improved a lot of guys

lives so people who have come through the institute it's

definitely strongly recommended if you can get yourself on the

PTM course you're specifically only interested in learning the

basics of trading psychology and applying that only to

currencies then the PFTM will cover that but if you want to

apply this to a much wider remit then strongly recommended

that you take the PTM video series as well. So let's get

started on risk management and there's a little secret that

you need to know which is there is nothing you know that the

market does Doesn't already know. Now that's a very strong

statement to make and it's one of the main reasons why we have

risk management practices in the first place. So even if

you've been through the whole idea generation phase and the

gatekeeping process and this all lines up and you're ready

to take a position. This is an assumption that you need to

make and you need to manage risk and also the opportunity

in order to make sure that you're not entering trades

where your idea and the timing looks good but you don't do

anything if positions go wrong and positions even go right.

Because there's no doubt about it. You're going to have

volatility in your positions and your overall portfolio. Now

all the information that we've been through in the idea

generation phase and also in the gatekeeping process this is

all actually publicly available information we're obviously

doing a hell of a lot more work than most people do especially

in the retail trader market but you need to make this

assumption. So let's go through it again. There is nothing you

know that the market doesn't already know. You have to make

this assumption because there's no way of you knowing that the

market doesn't know it. So by making this assumption it's

necessary therefore to have sensible common sense risk

management parameters overlaid onto your portfolio on all of

your positions and your portfolio in its entirety to

ensure that you don't blow up or you don't consistently lose

money. So this is one of the main reasons why we have risk

management in the first place is that if you go into a

position where you've generated the idea as part of an overall

large amount of ideas that are coming through your idea

generation process then you look to time these trades and

everything seems to line up nicely or the timing looks

pretty good it's always difficult to find ideas where

everything lines up in perfect order but if the timing looks

pretty good from a common sense perspective you can then still

put a position on and potentially lose money because

Everybody in the market is now putting on the position or

thinking of the same thing. So being slightly ahead of the

game is what we always want to be. We always want to be

looking forward. We always want to be increasing the odds in

our favour by being smart, looking at the right things,

doing more work in a lot less time, getting the right

answers, predicting what's going to happen in the future,

timing our as close to perfectly as possible. We're

never going to be perfect and then admit that we can still

get it wrong. Because there's nothing you know that the

market doesn't already know. If you make this assumption then

you're going you're going to have discipline. If you're

wrong you're going to look to manage risk correctly. If

you're right you're going to look to manage risk in that

scenario correctly as well. And this is what we're going to

move on to now. Uh we're going to actually play a game. And

this game highlights trading and human psychology very very

well and gives a lot of clarity as to why we even have risk

management processes in the first place. So let's start

this game and see how we get on. So what we're going to be

doing is we're going to be trading marbles. So you'll see

in front of you two boxes and in this scenario you are

getting paid. So what you're doing is you're actually

trading marbles against me. And in this scenario you're getting

paid. So if you win the game I have to pay you. If you lose

the game you have to pay me. But in this scenario you can

only get paid. You're winning. So what you'll see in front of

you is two boxes. Box A and box B. In box A there's three blue

marbles and one red marble. So four marbles in total. In box B

there's one marble and that marble is green now you've got

to put your hand in the box to pick the marble you only get

one shot in this game so you're allowed to pick from either box

and pick one marble so if you put your hand in box A and you

pull a blue marble I have to pay you 1000 pounds. If you put

your hands in box A and pull a red marble so the only red

marble that's in the box if you pull the red marble I pay you

nothing if you put your hand in box B if you choose to do that

well there's only one marble there so you'll have a feel

around in the box and you'll pull out the green marble if

you pull out the green marble, so if you put your hand in box

B, I have to pay you 700 pounds. So think about this for

a moment. You only get one shot. Which box do you put your

hand in? Box A or box B? I'll give you a minute to think

about it.

Box A or box B. If you put your hand in box A you pull a blue

marble I pay you a thousand pounds. If you pull the red

marble I pay you nothing. If you put your hand in box B you

obviously pull the green marble I have to pay you 700 pounds.

I'll give you another 20 seconds to decide.

Okay so have you made your decision? Have you put your

hand in box A? Or have you put your hand in box B? Remember

I'm having to pay you in this scenario. Write it down on a

piece of paper. Write down either box A or box B under the

title getting paid on a piece of paper. So write down the box

that you chose. So getting paid and then underneath write A or

B box A or box B write down your choice on the paper

Okay, done that. Perfect. Now, let's move on to the next

scenario. In the next scenario, scenario two, This is called

paying out. So in the scenario paying out the roles are

reversed in that you are now paying me. So you still have to

put your hand inside one of the boxes. But now you are paying

me. So if you put your hand in box A and you pull a blue

marble you have to pay me a thousand pounds. If you put

your hand in box A and you take out the red marble you pay me

nothing if you choose to put your hand in box B well there's

only one marble in there the green marble if you put your

hand in box B you will pull the green marble and you'll have to

pay me 700 pounds So paying out you are paying me but now

you're still putting your hand in the box. So it's not me

putting my hand in the box. You're still doing it. And

you're paying me so you pull a blue in box A you pay to me

1000 pounds If you pull a red from box A, you pay me nothing.

If you put your hand in B, you have to pay me 700.

Which box do you choose? Grab your pen and paper. I'll give

you 30 seconds. Write down scenario two paying out and

then underneath the title, write box A or box B. I'll give

you 30 seconds to make your decision from now.

So, blue marble, you pay me a thousand. Red marble, you pay

me nothing. Green marble, you have to pay me 700.

Okay so hopefully by now you've got your answer to scenario two

paying out. So we looked at two scenarios. Getting paid when

you get paid. So I have to pay you. And the second scenario

paying out where you still put your hand in the box but the

outcome is you're paying me let's go through the psychology

of what we just did there so in scenario one have a look at

your paper have a look what you wrote down in scenario one the

outcome was you were getting paid so So we can classify this

as you facing a positive outcome numerically. So you're

winning, you're winning the game, you're making money. You

get paid.

And when we look at the two boxes what they can be

described as in actually both scenarios because the boxes

stay the same boxes A and B can be described as risk and

certainty respectively. So box A is risk and box B is

certainty. And when human beings are faced with a

positive outcome human beings in the majority of cases will

tend towards certainty. So So in the scenario one, getting

paid usually eight out of ten respondents would actually tend

towards box B. And two out of ten would tend towards box A.

So 80% of people will tend towards certainty. And 20% of

people will tend towards risk. So Eighty percent of people

will choose to pull the green marble from box B because this

provides certainty that they're going to get paid seven

hundred. Now in trading this basically means taking profit

too quickly. Human beings focus too much on locking in profits.

And as traders what we actually have to do is the opposite. We

have to focus on letting our profits run. Now how from this

scenario how from this situation are we making a

profit? Well if you look at the risk adjusted payoff of each

box the payoff of box A is actually. 7575% chance of

pulling a blue marble of which there was three out of four

marbles so 75% chance of pulling a blue marble and

making 1, 000 pounds. So the risk adjusted payoff of box A

is actually 750 pounds. So it's higher than box B by 50 pounds.

So box eight risk adjusted is 75 multiplied by a thousand

equaling seven hundred50 pounds. The risk adjusted

return on box B is just a00% chance of making 700 pounds.

Now because the numbers are close together it's not so

obvious when you first look at it. But the principles apply.

If there were bigger numbers involved, it would become more

and more apparent. So if we take risk when getting paid we

make more than if we choose no risk when getting paid. And as

stated in trading this means taking profit too quickly.

Human beings will always focus on locking in profits very

quickly. So when you have a winning position in your

portfolio taking the profits because now we think it's

guaranteed to make money so we lock it in quickly. And what we

actually have to focus on is the opposite. Because that in

itself is actually just being human. There's nothing wrong

with being human. But when it comes to trading portfolio

management and money management we have to actually do the

opposite. We have to suppress our urge to tend to Certainty.

We have to focus on letting our profits run. So when we have a

scenario where we're getting paid we have to pull from box

A. The metaphorical box. We have to pull from box A and

keep our position and let it run.

To allow our profits to run we have to just accept the risks.

And just accept that risk exists. And possibly even take

more risk by adding more capital to the trade. So when

times are good on positions when we're making money we

actually have to seek out risk. We have to look to take more

risk or at least as a minimum run the position. So the

outcome here scenario one Getting paid when you do this

publicly when we take surveys on this with lots of people

involved especially in seminar rooms when the institute is

presenting live 80% of people in the scenario of getting paid

so facing a positive outcome making money will tend towards

box B and 20% towards box A. So if you wrote down box B there's

nothing wrong with that it just means you're being human but in

trading and portfolio management and in terms of risk

management you need to actually be doing the opposite so in

trading and portfolio management it's actually wrong

to look for certainty and pull from box B when you're getting

paid when you're winning so facing a positive numeric

outcome. Now what happens when we move to our second scenario

when you are actually paying out so when you are putting

your hand in the box choosing box A or box B and the outcome

was that you were paying me well in this instance you're

facing a negative numerical outcome because the outcome of

this game whichever box you put your hand in you have to pay me

and if you recall if you pulled a blue marble you have to pay

me £1, 000 from box A if you go in box A and pull a red marble

you pay me nothing and if you put your hand in box B you have

to pay me 700 pounds and if we think about this in the same

way as we looked at it before well the boxes haven't changed

the risk adjusted payoff of box A is 750, and the risk adjusted

payoff of box B is seven00 and if you put your hand in box A

you're essentially taking risk and if you put your hand in box

B it's certain the outcome is you have to pay me 700 so have

a look at your paper which box did you write down for the

second scenario paying out so facing the negative outcome of

paying me money well it. When this is done over many cases so

when many participants in a room are asked to write down

the answer to this question we get the opposite of the

scenario, scenario one, getting paid. 80% of respondents tend

towards or choose box A when facing the negative outcome and

20% choose box B. And this is again being human. When faced

with a negative outcome human beings tend towards risk

seeking behaviour. The vast majority of people will choose

box A because there's a chance that they might have to pay me

nothing or pay out nothing. But in the overall picture the risk

adjusted payoff of box A is seven fifty and off box B seven

00 so the way to think about this is take a risk and pay me

750 or pay out 750 pay out a certain amount with certainty.

And in trading and portfolio management in the scenario when

you're paying out and facing the negative outcome in trading

this means holding on to losing positions for too long so

instead of taking a guaranteed loss of 700 pounds as in

cutting the position the natural reaction or instinct is

to choose to hold on to the losing position or do nothing

and hope that you get out the position for nothing. So we

actually have to be doing the opposite again. In trading and

portfolio management what you have to be doing when you're

faced with losses is take the guaranteed loss not the unknown

loss. Because if you think about this now we've looked at

this as a one shot scenario in both scenarios of getting paid

and paying out. But what if you did this exercise over an

infinite amount of traits? Well, if you're getting paid,

so you have winning positions and every time you have a

winning position you pull from box B and you limit your upside

of the winning position and at the same time when you have

losing positions so you're in the paying out scenario you

choose to pull from box A then every time you have a winning

position you make 700 and every time you have a losing position

you're likely to be paying out 750 well it just means that

over time and over an infinite amount of trades you're never

going to make money in fact the most likely outcome is you're

going to be losing money. But if you do the opposite So in

the scenario where you're getting paid you seek risk and

the likelihood is you're going to make seven fifty but when

you're paying out you guarantee that you only lose 700 then the

likelihood is you're either going to over an infinite

amount of trades break even or make money so when times are

bad when we're paying out and losing money we pull from box B

we restrict our losses when we're winning we pull from box

A we take risk and uncap the upside to our winning

positions. We want to make sure we have as much upside as

possible if not infinite upside on our winning positions and

overall with very little to no risk to the rest of our

portfolio. So you can see now how human behavior in getting

paid tends towards certainty and when paying out tends

towards risk. What we actually have to do as traders,

portfolio managers, is take the opposite approach. And this is

exactly why we have risk management parameters and

principles in place in our retail trader books or even

professional trader books. This is all very basic stuff for

professional traders. This is exactly why they have strong

risk management principles and parameters in place. Whereas

retail traders don't really understand why risk management

exists in the first place and by not understanding it they

sometimes have risk management in place but by not Knowing

what it really means behind it become ill disciplined and

don't manage risk correctly. So this is very very important to

understand. And as mentioned previously this type of

analysis can be rolled out to many many other genres across

your entire life. So trading psychology in terms of

improving your longer term risk management in your portfolio.

And improving your returns on your positions and overall in

your portfolio can actually be applied right across your life.

If you want to know all of that stuff we go into great detail

in the PTM video series. But here we'll be looking only at

applying these principles to a currency portfolio. So how do

we actually apply this to the Forex currencies market? Well

it's the same as if we apply this to the stock market the

same as if we apply this to commodities or even the

interest rate bond market. The principles all stay the same

when trading any asset class in your approach to risk

management. The first thing we have to do is always ensure

that we use hard stop losses. So what do we mean by stop

loss? It means if you go long or short an asset you put a

guaranteed limit order to trade out of the asset if it goes

against you so for example if you bought an asset at 100 you

entered a limit order to sell your entire position if the

asset traded at ninety and then the asset trades at ninety, you

trade out automatically. This stops you from being human.

What it does is guarantee your downside. So, when that order

is triggered, you're essentially pulling from box B.

It's an insurance policy against you being human. So it

guarantees your downside pulling from box B when you're

paying out to the market. So when you're losing money. It's

stopping you from being human and seeking out more risk when

you're losing. So the human attendency would be to even buy

more at 90 and try to average all the way down keep losing

money and more and more money as the asset continues to fall

and the same on shorts if you short an asset at 100 you enter

a hard stop loss to guarantee your downside where if the

asset trades at 108 for example you trade out automatically you

pull from boxby So when you're paying out to the market and

losing money it guarantees you and it guarantees you what your

loss is so you know before you enter the trade what your

maximum loss is going to be. So what your tolerance for a loss

is and it stops you from being human. It stops you from

seeking out more risk and for example shorting more of the

asset at one oh eight then shorting more of the asset at

115 and 120 and 130 and so on and so forth. The first cut is

always the cheapest cut. Remember that quote. So

entering hard stop loss orders to guarantee your downside.

Pulling from box B when you're paying out. What about targets?

So what about when we're actually winning? Well, in

trading and portfolio management, we approach this by

using soft targets. What do we mean by soft targets well if

you purchase or go long an asset at 100 we don't want to

limit our upside and say for example at 110 we will trade

out automatically what we want to do is have a target whereby

we consider running or adding to our position when the asset

gets to that price so for example if we go long an asset

at 100 we may consider if it trades at 120 or 130 because

we're being paid we may consider running the position

or even adding to the position. So a soft target is a

discipline whereby we may enter an order to buy a little bit

more and this order itself at as a trigger or reminder to

make us think about our real risk in this position. So we

may enter a soft target of say 120 or 130 and if it actually

trades there so if we're disciplined enough or we're not

too busy enough where we can actually know that it's traded

there then we don't have to obviously enter an order we can

enter a reminder into the system where it can basically

ping us an email or it depends on the brokerage platform that

you use you can get a notification on your retail

brokerage platform that an asset has traded at a

particular price and then when it gets to our soft target we

consider our risk at that point in time So what does a soft

target do? It reminds us that we've got to a point where

we're considering adding to the trade or at least running it

and we're pulling from box A. So when we're getting paid by

the market and making money it's stopping us from being

human. So we don't trade out automatically when we're making

profits. We're actually considering the opposite. So

how would this look for example specifically applied to the

currency market well let's use Euro dollar so Euro USD as an

example and let's short sum theoretically at 130 so if you

sell Euro dollar at 130 and decide a sensible stop loss is

133 and a good target a good soft target is 121 and then

Euro dollar then goes to 121 within say seven weeks which is

a good time period for that type of volatility well what's

actually happened well on paper you have a mark to market

profit of nine big figures so big points not pips and what

you do in this in a winning trade is you must seek more

risk or at least run the position however in terms of

risk management the way you apply these principles is to

roll your stop loss from 133 down to one twenty-four so you

protect your downside on the trade. So what you're doing is

moving your stop loss from 133 to 120 four because now Euro

dollar is trading at 121 and you're running the winning

trade but in this situation now if you get stopped out your

profit is actually six big figures so 130 minus one

twenty-four What happens then? Well, basically, if you move

your stop loss from 133 down to one twenty-four, you've now

locked in an almost guaranteed profit. Because if the if the

currency pair Euro dollar from 121 goes lower you continue to

make money but if it trades back at one twenty-four you

make money anyway so what you've got now is a free trade

you lock in the potential profit now you will have some

gap risk which will come on to in a second but this is the

principle you have to stick to the gap risk is low it still

exists but it's very unlikely that you're going to get

stopped out on the trade above one twenty-four So the other

scenario that you might consider in this example is

actually adding to your position so let's say for

example when Euro dollar trades at 121 you double the size of

your position and that means by doubling the amount of notional

exposure to the position you've multiplied that by two so your

average price on the short will be halfway between the two

shorts that you've put on so the short will be one spot 2550

that's going to be the average price that you're short at so

let's say for example you shorted 100, 000 euro dollar So

one lot at 130. You put your stop loss in at 133 so you'll

automatically trade out of that $100, 000 if it trades at 133

so pulling from box B if it goes wrong and you're paying

out and losing money trade out automatically at 133 you apply

a soft target of 121 when it trades at 121 you sell another

$100, 000 so another one lot

you double the size of your position. So you do that your

average price on two 00 000 short is going to be one spot

two five five zero Now if you roll your stop loss down at

exactly the same time to one twenty-four if you get stopped

out so if Euro dollar goes from 121 to 120 to one twenty-four

therefore you getting stopped out you're going to you're

going to make one 2550 minus 1twenty-four so 1. 55 big

figures so one and ahalf big points essentially so what you

actually have because you have a free trade is a situation

where for every tick or pip or basis point whatever your

measurement is for every point that it goes lower you will

make double the amount on Euro dollar but you're also

guaranteeing that you will make some money on the trade. So you

cannot lose. So this is why we pull from box A when we are

getting paid. Because we can use risk management parameters

to actually enter a free trade situation. Now we did mention

there that you cannot lose. Uh it's very unlikely that you

will lose. You know currency markets are open six days a

week but there is some sort of gap risk still there. The gap

risk being that if the currency markets close on a Friday and

reopen on a Sunday you do have depending on where you are in

the world Saturday or Sunday gap risk where if a

macroeconomic event or information comes out that is

significant your stop loss may not get triggered at one

twenty-four if Euro dollar just goes up so closes on Friday at

121 and then trades at one twenty-six straight away on

Sunday your stop loss will be triggered if you leave it in

the system at 120 at one twenty-six. So you need to

understand that in the background there is still gap

risk in currencies even though market participants with

conflict of interest will lead you to believe always that

there isn't. There is still gap gap risk present when trading

currencies but hopefully you can understand the overall

approach to risk management here when we're using hard stop

losses and soft targets so when we're using stop loss in the

euro dollar example of 133 that's a hard stop loss we're

guaranteeing our downside we're pulling from box B if it trades

at 133 we just trade out we don't have to think about that

too much we don't waste our time on losses but when we're

winning we have two choices. So when we're winning we're

pulling from box A because we are getting paid and making

money. The first choice is to just run the position. But we

roll our stop loss down using common sense. Our stop loss

goes lower to a level which is still according to volatility

over the time period that we look at one to three month our

stop loss is still tight enough which gives us discipline when

trading out where the position goes against us but still wide

enough on our time frame of one to three months to give us a

continued or good chance to continue to make money on the

winning trade if we get stopped out we still make money so this

becomes a relatively low risk free trade our second choice is

to double the size of the position or at least increase

the size of the position and stick to the principle that our

new average price so in this example where we're short euro

dollar our new average price is above our newly rolled stop

loss which means we're still guaranteeing ourselves that

we'll make some money on the trade but now we're getting

double or at least more for every point the trade continues

to go in our favor. Now what would happen if we went long?

So we did it the other way round. Well we would ensure if

we're long our average price is below our stop loss. So if the

trade then went against us after we added to the position

we would get stopped out. But because our average price is

lower than our stop loss our automatic trade out would still

ensure that we're making some money on the trade. But for

every point Euro dollar goes up or the as in general terms goes

up we're making double or at least some more on the winning

trade now there are further principles that we have to

apply in our risk management of our trading book one of which

is seeking or using a 1 to3 ratio on all trades. Now in the

previous example it's not a coincidence that we selected a

hard stop. So a hard stop loss of three points. So three big

points in Euro dollar and a soft target of nine big points

in Euro dollar. Now when entering a trade and setting

our hard stops and soft targets we must always enter a

situation in which our soft target is within within the

realms of reality and is realistic and possible within

the time frame that we're looking at so within the one to

three month time horizon and by the same token our hard stop

losses must be wide enough to give ourselves a chance of

making money but not wide enough that we're being ill

disciplined and and allowing ourselves to be human. Now

setting a one to three ratio on all positions is a very good

discipline. What we actually mean by that is whatever your

stop loss is and bear in mind it has to be within the realms

of one to three month volatility you. So we're being

disciplined. We're not being ill disciplined. So whatever

your stop loss is if you multiply this by three this

should be roughly your soft target. So approximately your

soft target should be three times greater than your stop

loss. But the same principle applies in that your soft

target should be within the realms of reality when looking

at volatility within the one to three month time horizon so

let's have a look at this one to three ratio on our previous

example we had euro dollar short at 130 and a 3. 3 big

point stop loss and a soft target of nine points. so a

soft target of of one twenty-one. So our entry at 130

our hard stop loss at 133 and our soft target of 121 and

that's that's not an accident because when we look at Euro

dollar volatility these look like sensible targets over or

sensible levels over a 1 to 3 month time horizon I if we

first look at the one to three ratio the reasons why we do

this is because it's simply good discipline and there's

three main reasons for doing it.

If we want to get paid at least three times what we pay out

then we're not going to enter trades that we look at and we

decide that they don't provide us with at least this potential

payoff and that can only be a good thing. It means we're

looking at volatility. We're looking at the realms of

reality in terms of volatility. We're setting our stop losses

at sensible common sensical levels and we're setting our

soft targets at sensible levels so within the realms of

possibility on a one to three month volatility or time

horizon and our soft targets on a payoff of three times that of

our stop losses and we're saying if we don't see the

possibility of making that on our targets then we won't be

looking at doing the trades at all. Secondly if we trade out

of all our losers at our stops and all of our winners at our

targets so not adding to the position or running to the

position if it's winning if we just trade out at our stops and

we trade out at our targets then on a risk reward ratio we

only have to get 33% of our trades right so if two thirds

of our trades go wrong and we get stopped out but one third

of our trades go right and hits our targets we break even. And

this takes the pressure off us not requiring a very high win

ratio to make money. So the percentage of the trades that

you win on is your win ratio and the percentage of your

trades that you lose on is your loss ratio. And if we get more

than 33% of our trades right when we're trading out at both

our stop losses and our targets we will be making money which

is obviously a good thing which is our objective and if we add

to our winners so the third reason as to why setting a one

to three ratio on all positions is a good discipline is if we

add to our winners and then we get paid more than we can get

less than 33% right. So all round adding a one to three

ratio on all positions is a very good discipline. So we've

picked up quite a lot of important principles there. Uh

firstly obviously picking up the box A box B principles. So

always pulling from box A when getting paid and always pulling

from box B when paying out and therefore doing opposite of

human nature in which people always look towards certainty

when getting paid off so looking towards pulling from

box B when making money and looking towards seeking risk

when paying out so when losing money seeking more risk. We

want to be doing the opposite of that. We want to be pulling

from box A when getting paid and pulling from box be when

paying out and also picking up the principle here of entering

trades that present at least three times more upside than

potential downside. But how do we actually set our stop losses

and targets on currency trades well here we're going to use

the Euro USD example as before when we looked at the previous

example we used points so big figures as stop losses and as

targets this was deliberate and for illustrative purposes in

order to simplify the concept for you so you shortcut to its

conclusion and understanding. What you'll recall is that in

all of our volatility so opportunities analysis we

measured everything in percentages or base metrics and

it's no different in risk management practices because

we're literally looking at the same data. What matters is the

volatility over the time frame that we're looking at. And if

you recall opportunity and risk are literally the same thing.

You just can't have one without the other. So we need to take a

very common sense approach using our risk management

principles. So we set percentage soft targets based

on opportunity and hard stop losses based on risk risk. So

we're now going to go back to the spreadsheet that we saw

much earlier on in the video series. ATR rankings and

analyse ATR in order to set sensible stop losses and

targets and stick to our risk management principles at the

same time. So what we're essentially doing here is

looking at a theoretical trade that's come through the overall

idea generation process the gay keeping process has ticked many

of the boxes so our timing looks good and now we're

choosing to enter the trade take a real position and we

have an overall trading opportunity and risk assessment

in order to set our hard stop losses and soft targets so we

essentially have a plan when we're entering the trade

deploying capital and this position becomes a real

position in the portfolio. So if you go to the download

section we have a an updated version of the ATR average true

range rankings spreadsheet where we have an example in

there for Euro dollar so if you keep your ATR rankings

spreadsheets for the tradeable set always up to date you'll be

to access the data and look at the historical volatility

assessment which is backwards looking obviously but you'll be

able to use this to enable you to pick your stop losses and

your targets very sensibly. So let's go over to the

spreadsheet ATR rankings. And if you recall we had our entire

tradeable set with our daily weekly and monthly rolling ATR

numbers and we have them we have them ranked and you can

see here that our monthly ATR on a one year rolling average

for euro dollar is just under three point three percent. So

if we use the example that we were using earlier where Euro

dollar is at 130 and we're not applying a points system we're

applying a percentage system then we're going to assess on

our time frame one and three month volatility and look at

our theoretical soft target and our theoretical stop so we're

going to be referencing the cell here Dtwenty-five now if

we go to this cell here Ftwenty-five or we have do is

multiply across by three to get our three month volatility

using our one month volatility so we end up with 9. 87% and we

can change this to percentage and we can change this to two

decimal places and we have our one month volatility which we

know

is around 3. 3%. So we can change this to percentages.

And all we have to do is take the euro dollar price and work

out how many points for a theoretical soft target and

theoretical stop loss are required as the parameters for

this volatility calculation. So we take the three month

volatility and multiply it by one point three. So we have our

theoretical soft target number of twelve points or just under

13 points. Our theoretical stop is simply the one month

volatility times 1. 3, which gives us 4point2 or just under

4 point three points. So when we work out our soft target we

simply minus this number off if we're going short and this

presents us with our theoretical soft target

we add

this on to 1. 3 and we get our theoretical stop loss. Now,

when we look at these two numbers here, what we need to

do is remember our risk management principles.

So when we look at stop losses first our theoreticals our stop

loss that we actually want to apply needs to be within the

realms of possibility and be tight enough so that we're not

being ill disciplined but wide enough to still give us a

chance of making money. So going short Euro dollar at 130

if we put a stop loss in by looking at these numbers if we

decided a sensible stop loss is 138 well we're just kidding

ourselves because we know one month volatility is 3. 3% and

from where Euro dollar is trading one 3428 means that in

an average month if it goes against us it's going to

probably to around one thirty-four. So 1 38 is

obviously being very ill disciplined. If we're wrong for

an entire month then we're probably going to be wrong for

a very long time. So probably wrong over our entire 3 month

period. So we have to cut and having a sensible stop loss is

within the realms of possibility so using the

monthly volatility as a yard stick to measure What's

possible and deploying some common sense. Now if we did the

opposite of being ill disciplined and we wanted to be

ultra disciplined and said well why don't we have a stop or one

thirty one thirty-one. Well it just means we can be stopped

out very very quickly. And we're not really giving

ourselves a sensible chance of making money in this scenario.

So we're not looking at monthly volatility really if we choose

a 131 stop. We're looking at weekly or even daily

volatility. So what we need to Think about here is having a

sensible stop loss around one month volatility. So around 133

134 is probably sensible and then we're looking to multiply

that by three as a soft target. Now if we go inside that number

and multiply by three then our soft target is going to be

higher than 117. Now we know that it's possible from our

three month volatility analysis that Euro dollar could quite

easily within three months trade towards 117 or even trade

at 117 so we have our soft target at either three times 3

9 points or four times 312 points and take this away from

130 so we're either going to have a soft target of one

twenty1 or a soft target of one eighteen. And both of those

soft targets are within the realms of possibility based on

our volatility analysis. Now one other thing that we could

consider doing that we decided or looked at is a good

potential strategy when entering trades from a risk

management perspective earlier on in the video series is to

look at taking a starter position. So what we could

actually do here is put on a half size position rather than

put on our full size position and widen the stop loss and

widen the target. And add to the position when it's actually

working so for example if our full position size is 100, 000

currency pairs so one lot and it and that's the limit that we

put or put on ourselves when trading currencies in our

portfolio then this means we could short 50, 000 so five

mini lots in portfolio so 50, 000 gross exposure to one

position at 130 and if it trades lower to say 127 128 we

could then add to the position and then put the stop losses on

from that point but we could actually when we put the

starter position on make the stop and the target twice as

wide. So instead of having a three point stop loss have a

six point stop loss. And instead of having a 12 point

target have a twenty-four point target. However we know when

entering the trade we're either going to cut it or add to it

when it's winning. So we know that a twenty-four point target

is very unrealistic but we're not at our full position size.

So we're in this scenario we're either going to get stopped out

on a starter position or we're going to be adding to it when

it just starts to work in our favor and deploy some common

sense. So before we go before we add to the other 50% to the

position and increase it to a full position size. And then

when we do increase it to a full position size we then look

at our one month ATR and go through this exercise again and

come to the conclusion of what our hard stop loss our new hard

stop loss is going to be and our new soft target is going to

be before we even add to the position and roll our stop loss

now there's something to cover there as well if you have a

gross exposure limit on one position in a currency pair

which is 100, 000 currency pairs or one lot and the trade

becomes what we call a winning trade because it's traded very

close to or at your soft target

when you have these exposure limits because your trade and

you're rolling your stop is becoming is becoming a free

trade because you're basically guaranteeing that even if you

add to the position you're going to make money when you

enter that situation you are actually allowed to break your

risk metrics because you basically cannot lose so you

get big and you run the position. When you're in a

winning position you have a lot more choices and your life

becomes very easy. So when you're actually just running

the position to a point before it gets to your stop before it

gets to your soft target you don't have a huge amount of

choice until the trade is really proving to you that it's

working and you're winning and doing well on the trade and

then you've got enough room to maneuver to add to the position

and create a situation by rolling the stop loss where you

have a free trade. So in this example with Euro Dollar if you

remember from earlier in the presentation we shorted Euro

dollar at 130 and when Euro dollar went to 121 we then

added to the position by increasing or doubling the size

of the position and our average price became one 2550 and we

rolled our stop loss to one twenty-four thus ensuring that

we would guarantee that we make money on the trade so we'll

make one and a/ 2 points we're making something but we're also

opening up the possibility that if Euro dollar continues to go

lower we actually make double the amount of money for every

point or tick or pip or basis point that it does go lower so

overall in that example what we're showing is that we've got

guaranteed downside on the original trade where we have a

stop loss. Our downside is absolutely guaranteed and we're

going to be pulling from box B and make sure our stop loss is

triggered and we trade out of the position. If it goes in our

favor and reaches our soft target then we're looking to

pull from box A. But sticking to the principle that we don't

obviously trade out we roll our stop loss and when we roll our

stop loss it's below our new average price which opens up

the possibility of us making even more money but at the same

time guarantees that we trade out and pull from box B if we

then begin to enter a situation where the trade is going

against us so as we build out the position the risk becomes

asymmetric so we end up with a free trade so overall you can

see how this works now on a one to three month time frame

rather than looking at very short term time frames coming

up with poorly thought out ideas only looking at things

like technical analysis to generate ideas not deploying a

gatekeeping process that's overlaid to an idea generation

process which is fundamentally driven and then timing is

technically driven and risk management is volatility

dependent. You can see how this works now when we do it in a

proper overall professional trading systematic process. Now

one other thing that you can consider doing after looking at

the volatility assessment and deciding what your sensible

stop losses and soft targets are going to be then for

example with soft targets around your soft target if

there's key technical levels in the currency pair then you can

use those technical levels as well where if they break those

technical levels convincingly then you can actually go in and

if it hasn't quite reach your soft target or it's reached

your soft target but hasn't broken the technical level you

can actually consider in the previous example of if it's not

to reach your soft target but it's broken the technical level

adding to the position and if you if it's your if it's broken

your soft target adding to the position as well because now

the market will be very focused on the fundamental drivers that

have occurred that have made the currency pair break a big

or Important technical level. And as we were talking about

earlier Don't worry too much about the small things. Get the

big things right when it comes to technicals. Everybody can

make a claim that there's an important technical level every

single day in every single asset because you can find

reasons to find technical levels get the big ones right

so get big support levels get big resistance levels get the

big commonly formed patterns correct and these are the this

is the approach that's going to make you on the 1 to 3 month

time horizon with well thought fundamentally driven ideas, a

solid gatekeeping process, and a solid volatility dependent

risk management plan, this is the approach that's going to

make you the big money. Instead of sitting with a retail

trading account that just dribbles out money and loses

money every day. This is the approach overall that's going

to make you the big money. And you've just gotta stick at it

and be patient. So that brings a to the end of having

discipline or risk management number one let's go back over

to the trading desk for a recap okay so welcome back to the

desk what you just saw there is probably one of the most

important things in trading all of these risk management

principles because throughout an idea generation process

throughout a gatekeeping process you can still always be

in the position where you can lose money because you manage

risk badly trades can go wrong, trades can go right. More

frequently, trades for retail traders will go wrong versus

right but the way you treat your losers and the way you

treat your winners sets you apart as much from everybody

else as to your idea generation process, your gatekeeping

process and all of that combined because you can still

come up with great ideas, time them well, but manage your risk

badly. So if you think about this in an overall process risk

management fits in to a point where we have fundamental ideas

that increases the probability that's making money through the

idea generation process because we're concentrating on

fundamentals and we're looking at the fundamental picture in

the bigger picture one to three months moving forward. We then

fully admit to ourselves that a idea is just an idea and we can

still mistime it. So we have a gatekeeping process which stops

us doing stupid things. So the gatekeeping process is a layer

that stops us getting into good ideas that are mistimed and we

get stopped at or bad ideas altogether. We then have

another layer of risk management which then basically

stops us doing silly as well when we have real positions

with real money. And the underpinnings of understanding

why we have risk management in the first place is really

important to understand. Because if you don't understand

this stuff when you end up with real positions you won't

respect risk management. You will just keep thinking that

you're right all the time. And you'll end up averaging into

losers and losing a lot of money. So the most important

thing to understand here is really that if you get to this

point and you've been through the fundamental processes

you've got fundamental trade ideas those ideas are just

ideas so we know we have to look to time them better we

then think that the timing is optimal and we're looking to

deploy capital and we end up with a real position you have

to make the assumption still that there's not that you don't

know that the market doesn't know and you have to understand

human psychology. If you don't, you won't respect risk

management and you'll end up being one of these arrogant

traders that ends up thinking they're always right but you'll

always lose money. So, you have to be good at risk management

as much as you are good at producing really strong

fundamental trade ideas and timing them well. Now because

of the assumption of the market because of human psychology we

understand that now and we understand why we have soft we

have soft targets and hard stop losses but also why we analyse

everything on a 1 to 3 payoff ratio it's so we can basically

protect our downside and unleash our upside on every

trade now a really good example of that was euro dollar and

this principle that we introduced you to with that

example is the principle of trying to find the free trade

and that only happens once you've got a position and this

principle of the free trade is extremely powerful because when

you're trading over one to three month time horizons and

going for the percentage moves that we look to go for over

those time windows so having the three percent stop loss

with the nine, 10% soft target. When you're going for those

size moves and you start and they start to play out and

start to break technical levels, you can start adding to

positions in a way that ensures you can never lose money

because your risk management is strong and you're trading over

a time horizon that allows you to do this and your funding

idea is starting to play at and when you add to these positions

rolling your stop in a way that ensures you simply cannot lose

money when you've added to the position but now you're

unleashing the upside in profit on the trade and capping the

downside to ensure that you're still going to make money this

principle of free trade is extremely powerful and the

whole and as part of an overall process it's extremely guys at

the institute have had incredible successes in their

trading accounts by applying these risk management

principles to fundamental trade ideas that have been timed well

and they come up quite often you know they come up several

times a year where you have a big winner in your portfolio

because it's fundamentally right you've timed it really

well and now you're adding to it and managing your risk

really well on the principle of the free trade in as you guys

have been short Euro dollar made a ton of money on that

that's one of the reasons why we use it as an example because

it was a classic example towards the end of 2014

beginning of 2015 made a ton of money on the oil move down from

100 bucks down to 50 bucks they were shorting it all the way

down and making sure that their risk management was perfect all

the way down and that the stop loss was always ahead of the

average price which ensured if they get stocked out they would

always make money and they've done it continuously in a

number of stocks when they're long and short in their overall

long short portfolios and the principle applies to currencies

of course it does it applies to every asset class you know the

guys have great successes on Euro dollar and one of the and

this principle was applied all the way down So, the big things

here, make sure you get the big picture, right? The big picture

is fundamental idea generation. The ideas come out of the idea

generation process, gatekeeping timing that's there to stop us

doing stupid things. Risk risk management is there to stop us

being human. And you've gotta be a good risk manager as much

as generating your ideas. Okay, so now let's move on to having

discipline two risk management two we're going to look now at

more parameters that we can deploy into our portfolios so

more risk management parameters that will make us better

traders in terms of managing our risk over the longer term

and being consistent in our approach. I'll see you in the

next video.