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Assigning Risk Levels to Your Potential Trades - 12-14-2003

Question:

In the trades you outline in your E-zine, you assign a risk level Low, Moderate, High. I was curious as to how you determine the level of risks on these trades?

I did not find this information in your manual, which I find an excellent work by the way. I also did not find it on your site. I would love to learn how you go about assigning risks.

Answer:

This is a very good question and something I guess I should’ve addressed earlier. I assign the risk level by the likelihood I think the trade has of begin successful. There really isn’t a formula, other than the strength of the support and resistance that I’m basing the trade on and the amount of money at risk.

For instance, the week before I think I gave the Canadian Dollar trade a “low to moderate” rating. This was based on the very strong resistance that the market was up against combined with the pending RSI bounce. This made me fairly certain the market would behave as expected.

This last week however, the market has rebounded back to that same resistance line. This makes me a little less comfortable with the short position since the bulls are not giving up; therefore we MAY see a breakout above the resistance. This added uncertainty made me upgrade the rating to “moderate to high”.

Sometimes it is just the amount of money at risk, or how the market has been behaving. Cotton and silver have both been “nuts” lately. Combine this with these market’s abilities to make $1000 ranges in a single day and you will know why I would be hard pressed to offer anything less than a “moderate to high” rating at this time.

Conversely for the opposite reason I might assign a lower risk rating to a trade with a small risk exposure. Take last week’s Live Cattle trade. Cattle can make large ranges too; however there was only $160 at risk, so while the trade might still be “risky” it is not as risky given the risk exposure of the trade.

Likewise if the market has to move a great distance to find the profit target this also raises the riskiness of the trade. If we’re looking for the market to make a larger move to make the trade worthwhile, then this would also increase the risk rating.

That, in a nutshell, is what goes through my mind when I’m assigning the risk rating to a trade. Hope that helps clear things up for you.

-Erich

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