Choosing to Increase Risk | Podcast Episode #187

0:07
Hey, I’m Ryan Mallory and this is my Swing Trading the Stock Market podcast. I’m here to teach you how to trade in a complex, everchanging world of finance. Learn what it means to trade profitably and consistently managing risk, avoiding the pitfalls of trading, and most importantly, to let those winners run wild.

0:25
You can succeed at the stock market and I’m ready to show you how. Hey everybody, this is Ryan Mallory with Swing Trading the Stock Market and got a good episode where you guys here today coming from a guy named Joe Bob. Or that’s at least what he wants to be called. Because I don’t use people’s real names when I get these emails.

0:43
And remember, make sure to keep sending me your questions about the stock market strategies. I love using them for my podcast. It’s a good chance that you will get a podcast episode dedicated to answering your questions, so send them to ryan@shareplanner.com. Also, make sure that you sign up for swingtradingthestockmarket.com.

0:59
It supports this podcast. You’re going to get all of my market information each and every week. That’s going to include S&P 500, NASDAQ 100, Russell 2000 updates, my indicators, my weekly watch list as well as daily trade setups and some of the most intriguing charts that I come across each and every day.

1:15
Also all the paying stocks as well, so make sure to check that out. swingtradingthestockmarket.com Now Joe Bob, he’s new to trading. He says. I’ve been binging your podcast. I had no idea you started doing this in 2007 and you have such great content. I’ve lived in the greater part of my life in Baton Rouge, LA, and I’m new to trading with my first year under the belt and I’m just trying to absorb everything up like a sponge swing.

1:39
Trades and options swings have been my comfort zone as I find out more about my preferred risk and discipline areas. I actually do have a question that I would love to know your opinion on. When you trade a stock, would you ever be willing to risk 20% on a stock that you believe has a 3X or better return potential long term?

1:57
Or maybe what I am asking is how should I try and define acceptable risk amongst the potential return, but I’ve never considered such a large loss potential. Or am I making this too complicated and stick to the three to one reward to risk ratio and not necessarily look at percentages?

2:15
Sincerely Joe Bob. So for the drink that I am having for this podcast, it’s my old Fashioned. Every once in a while I’d like to bring back up my old fashion that I’m using so that you guys can have the same old fashioned at home and enjoy it just as much.

2:31
This time though, I put a little bit of A twist on it. I used instead of a simple syrup, I used a organic agave nectar and it’s really good. It changes the complex a little bit, makes it a little bit spicier while keeping that sweetness still intact. Also a little bit thicker too, of a oldfashioned.

2:48
Not too much, but just a little bit more of that. Gave nectar. Seems to be a little bit of a thicker substance, but it makes it really good. My wife, she actually likes it better. I find that insulting, Frank. I think my original is the best, no? But all kidding aside though, for those who are wondering, my oldfashioned, I give it a 10 out of 10.

3:05
It’s just that good. And I use 6 dashes of the angristic bitters. I never know if I’m actually saying that right. I use two dashes of the orange bitters, 3/8 of an ounce of simple syrup. Or in this case I would use maybe like 1/4 of an ounce to 3/8 of an ounce of the organic agave nectar.

3:22
Then I use 2 ounces of the Knob Creek Nine Year Bourbon. It’s pretty good. You can get a big thing of it at like an ABC Liquor or a Total Wine. Then I put a pretty good cherry and you don’t want to get that like cherries. You get that at the grocery store. You want to get like a high end cherry that has a real good sweetness to it.

3:39
I put that in there and then I put an orange peel. I express it over it and voila, you got a good oldfashioned. Now to answer Joe Bob’s e-mail and more detail here. First of all, he’s new to trading for one year. He’s a newbie and a lot of you guys listening are newbies and that’s great. I hope you guys continue to listen.

3:54
I think a lot of times people get too much confidence too quickly and they’ll say all right, peace out Ryan, I’m not listening to your podcast anymore because I got it figured out. I don’t want you guys to do that. You want to continue to listen to this podcast because you’re going to continue to learn and you’re going to continue to develop more as a trader. Whatever you think you know now, it’s small potatoes compared to how much you still have to learn.

4:14
And the moment that we have confidence in the market is usually when the market wants to knock us down some. And right now the market is still rewarding risky behavior. So for a lot of you guys, watching the stop losses and how critical they are really hasn’t been shown to you up close. And so for Joe Bob here, he’s new to trading for just one year.

4:33
And the one thing that concerns me the most about this e-mail was the part of the e-mail that wasn’t even a question. It’s where he says he likes to swing trade stocks and swing trade options. And that’s a bad thing, especially when you read a little bit further down and he says, I’m still trying to figure out my preferred risk.

4:48
Well, options are incredibly risky. I think it’s like 90 or 95% of them expire worthless. And there’s so many different variables that goes into the options, the strike price, the amount of premium that you’re buying, that option for, the expiration, the time decay, the gamut, the delta, the Theta, all that stuff, okay, it goes into options train.

5:09
It’s very, very difficult. And then when you start doing complex options, trading makes it even more difficult. And here’s the thing, even if you’re right about the direction of the stock, doesn’t mean that you’re going to make money off of the options because you’re fighting time. These things are eventually expiring, and the closer you get to that date, the less that they’re worth if they’re not in the money.

5:28
So Joe Bob, if he’s still trying to figure out his preferred risk, it would seem like it would make sense to me, is to keep trading as simple as possible, avoid the options, focus on swing, trading the equities. And that’s all I do. I don’t trade options because it doesn’t fit my risk profile and that’s after having done it for many, many years.

5:46
I just know that options are not the best vehicle for me. Now that doesn’t mean that I don’t ever trade options. I’ll do covered calls and I enjoy doing those on some of my long term investments. I think that if you can get a good premium that you can sell a call at, sure, I’ll sell the covered calls. But I think a lot of times, and possibly in Joe Bob’s case here, he’s just buying calls or he’s buying puts, but most of the time those things are going to expire worthless.

6:08
Now a lot of people say, well, you’ve managed the downside risk on things, and that can be preferable if you’re like shorting the stock market because at least you don’t expose yourself to infinite losses like you can if you’re shorting equities. However, still the potential for a loss even when the stock ultimately goes your direction because you ran out of time on your options is real.

6:28
So for somebody new to trading, I always think that it’s probably best to avoid the shorting, avoid the options and just focus on being long on equities. If the market’s not behaving well or if it’s in the middle of a correction, just stand aside, let the market correct. You don’t have to lose money with everybody else, just stand aside. I mean, right now, I don’t think there’s a lot of opportunity in this market right now.

6:45
I’m still doing my research like I do each day. I’m still doing tons of chart sizes if it’s the busiest time of the year for me in trading. But I haven’t made a lot of trades lately because I don’t think there’s a good reward to risk currently in the market right now. I do have a short position on the market on the Russell 2000, but I’m not very aggressive on the market right now because I’m waiting for better opportunities and I haven’t even made a trade in a solid week.

7:09
I mean that doesn’t happen very often And it goes back to the point with job I was like, hey, look, you don’t have to go out there and start off trading by getting into options and getting into shorting and everything else. And instead it’s better to focus on the long setups because those are the ones that you’re going to learn the most from right out of the gate.

7:26
And it’s also going to keep you away from a lot of risk. And when the market does correct, you don’t have to be short it. Instead, you can wait and you can wait for it to settle in. Find that bottom and then you can start getting long again. In essence, options will increase your chances of failure as a trader and especially as a new trader.

7:43
Now his e-mail gets a little bit more complicated as he asks about he wants to risk 20% on a longterm trade in order to make 60% return. Well, why do you necessarily have to risk 20%? Is there a reason for risking that? Or is it because you think that you can make 60% on the trade that hey, that gives me a lot more wiggle room.

8:01
What it sounds like to me is is that Joe Bob’s afraid of losing out on this trade. So he’s like, well, since I can make 60% on the trade, I can go 3 to one on the reward to risk still and I can risk a far bigger amount. But really you should be asking yourself what’s the best ideal location to put my stop loss at?

8:18
Now that’s not contingent on how much reward you can get out of the trade. The risk should be looked at first. Where do I put my stop loss at relative to my entry? And it’s also important to know too, what is the Max amount of risk that you’re willing to take on a trade or on an investment.

8:34
If your risk tolerance is I can only handle a Max of 10%, then you should completely ignore the trade setups that would require you to take 20% or 30% on a trade. Because the bigger the risk, the more that you need to make it a justifiable return. I mean, what would be better is if that he says, hey, you know what, this thing has a 60% longterm potential and I only have to risk 5%.

8:54
Well then all of a sudden this guy’s getting like, what, 12 to one? That would be ideal. Or maybe it’s 10% that he has to risk. Why risk more than 10% if you can see that if it crosses a certain threshold at 10% that all of a sudden this trade has gone to crap and you don’t want to be in it anymore?

9:09
That’s what the stop loss is for. It’s when the stock goes to crap and you don’t want to be in it anymore, something’s wrong. You don’t have to wait for it to get to 20% if you can figure that out at 10% or 5%. But again, I think Joe Bob wants to risk 20% because he doesn’t want to lose on the trade. And sometimes, especially with men, they have a much more difficult time accepting losses.

9:30
They take it as a win loss thing. Their ego gets in the way and they’re like, I don’t want to lose, I don’t want to lose. I’m holding on. But he’s asking how should I try to define acceptable risk amongst the potential return. Well again, the risk that you’re willing to take on a trade is not contingent on the return. The return justifies the risk.

9:47
So if you look at stock A/B and C okay before you even consider the reward, you look at the risk you get into stock ABC and you’re saying, hey, the ideal entries at $100, the place that I want to put my stop loss at. But when it becomes clear that this trade is not going to work for me or something is very much wrong and I don’t want anything to do with it, is at $90.00.

10:06
So I’m taking a 10% stop loss. Okay you’ve defined the risk with complete disregard for the reward and that’s what you should do. After you’ve defined the risk. Then you look at the reward and you say, okay, how much reward potential is there on this trade? If it comes back and you only see the upside being 110 dollars, well then you pass on the trade because that’s a one to one.

10:26
If it’s 120, then you got a 2 to one and that’s more ideal. 3 to one’s great. Anything more than two to one is what you want. So 2 to one and above. Those are ideal reward to risk because you can do well with those kinds of numbers, but you don’t want to do this.

10:42
You see stock ABC trading at $100 and you’re like, oh, I think the stock will go up to $150.00. All right, now I’m going to define the stop loss. Well, since I can make $50.00 to the upside, I’m going to go ahead and put my stop loss at $25.00 to the downside. But in the previous example we just saw that you didn’t have to put it any less than $90.00 for it to be a good stop loss, and instead you’re putting it at $25 just so that you can stay in it longer and increase your chances of hopefully being right.

11:10
That’s not what you want to do. So in the end, risk is defined by itself, okay? You don’t make it based off of what the potential reward is and so you don’t want to increase risk unnecessarily. Do I ever increase risk in general? Yes, I will, but I’m also comfortable with it in that circumstance.

11:26
I know the kind of losses that I can take and that I can’t take, but it’s also going to be dependent on the market situation that I’m in. The stock that I’m trading some of the more volatile stocks does require a little bit wider stop losses. But I’m not going to say, hey, I’m going to get into Roku here at $200.00 a share.

11:43
I put my stop loss at 100 because I think that I can make all the way up to 400 on the trade. Not gonna happen. I’m only going to go after those trade setups that have stop losses that I’m comfortable with and I’m not going to make that based off of the reward itself. All right, Well, that’s going to do it for this episode here.

12:00
Make sure to continue to leave five star reviews for me on Apple, on Amazon, Spotify, whatever podcast platform you listen to, Make sure to subscribe and leave a good review for me. Those mean the world to me. I think you guys are amazing and you continue to send me some great questions. Again, shoot me your questions. ryan@shareplanner.com.

12:17
I read all of them. So thank you guys. Thanks for listening to my podcast Swing Trading the Stock Market. I’d like to encourage you to join me in the SharePlanner Trading Block where I navigate the stock market each day with traders from around the world. With your membership you will get a seven day trial and access to my trading room including alerts via text, e-mail and WhatsApp.

12:38
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12:59
All the best to you and I look forward to trading with you soon.