Risk Management for Technical Traders [Interview Excerpt]

Tips from EWI Senior Analyst Jeffrey Kennedy's Stocks and Commodities interview

By Elliott Wave International

If you trade with Elliott wave analysis, your trading decisions
are all about the difference between where the market is vs.
where it will be. According to Jeffrey Kennedy, editor of
our Elliott Wave Junctures service, risk management
skills are vital to being a successful technical trader.

Here's what Jeff had to say in a recent interview:

Risk management is all about consistency. It is all about longevity. It is like going back to the story about the tortoise and the hare. You want slow or small consistent profits...

Being an analyst and trader involves two totally separate skill sets. As an analyst, you are a master of observation. You are focusing on what could happen. As a trader, your primary focus is on what is happening. Regardless of whether you think the market's about to top, if the trend is up, as a trader, you've got to play it. Divergence is a great example of what I am referring to.

As an analyst, if I am looking at a momentum tool, and
I see divergence, well, that is suggestive of market weakness.
As a trader I have to focus on what is happening,
not what could happen.

If I see the daily trend is up, I have to buy the market. How do I resign myself to the fact that I have divergence, which means a decrease in momentum, a possible weakness, and a possible trend change? I have to focus on what is happening as a trader and the trend is up. How do I reconcile that?

This is where risk management comes into play. For example, you are allowed to play the buy side to the tune of $100,000. If you are seeing divergence begin to enter the market, you may say to yourself, "I have to trade the trend, and the trend is up, but because of this divergence, I am not going to go all in." ... [and] you have to have a very tight stop on the position.

... That is how risk management comes into play, and how
you focus on what is happening and reconcile what is happening
as a trader. But you also have to take into consideration
what could happen when you are wearing your analytical hat
and see that potential for divergence because there are
markets I have seen where the divergence continues for six
months. Analysts trade what could happen, whereas
traders trade what is happening.

Effective risk management is indispensable to successful trading. Ultimately it doesn't matter how accurately you spot divergence or label your waves if you risk too much on your trades.

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