The Future of your Risk Management
Seth Godin says its best in this post.
It is the future that makes people buy stock it is not the past.
When you think about risk management, this becomes very important. People are not interested in what happened months ago because all is done and said and more important it already changed their account. It still might do that in the future but it is more likely that new news are far more interesting.
Thats one of the reasons why technical analysis is overrated. It does look back, it does not look forward. When investing you should always look forward, invest in the future not in the past.
So when considering risk management in your investment approach, start with your current system. Does it look backward, is it a technical approach? If you work with moving averages, MACD, stochastic, Elliott Waves or any other fancy technical approach you are searching for clues in the past. Stop doing that! Start looking for clues in the future.
Let´s elaborate. When i use moving averages and my system does give me a long signal i tend to go in because i assume that that stock will go up in value. But how much money do i earn when entering the position? Right- nothing, instead i lose, because i have to pay a commission to my broker.
Well then, when do i make any money? Only if the stock goes up and i sell at a point in the future. The money i will make comes from closing the position not opening it, so here we are again, we make the money in the future not in the past. Did it help to use moving averages and follow the signal? No, it just gave me a signal to enter the position but the minute i did that i was a random entry for the market. That´s right i was a random entry nothing more.
My analysis did not help to make money it was the exit after the price of the stock went up that made the money.
So we need to apply risk management for our future investments not for what we see in the past.