Most of us don’t like uncertainty.
But after last week’s election, I’m expecting uncertainty ahead.
Now, don’t get me wrong. I’m not passing judgment on President-elect Trump’s proposed policies.
But big change-ups make it inherently more difficult to see how things are going to pan out.
Tariffs on imported goods are likely going to set off a trade war. They could also heat up inflation again.
Pair that with the Federal Reserve’s 0.25% rate cut last week after weak jobs data. The next administration’s policies might force the Fed to hold rates higher than desired to keep inflation at bay.
The Fed’s much-desired “soft landing” would become harder by the day.
But whether it’s a new president putting a protectionist policy in place… or a shock like we saw back in early August when the yen carry trade unwound…
There are always going to be events that investors don’t foresee. And those moments can throw the markets completely off balance.
Yet one simple premise has helped me successfully navigate shocks and surprises throughout my 40-year career.
Let me explain what it is… and why you should keep it in mind over the coming year…
Accept That Shocks Will Happen
You can’t avoid market shocks.
You simply need to accept that they’re going to come.
No two surprises start the same way. So trying to predict the next upheaval is a futile exercise.
There are just too many moving parts. The crosscurrents across global markets and the major economies are way too complex – especially if a trade war unfolds.
With that in mind, the best way to navigate shocks is based on what we can actually control.
That’s simple: Manage your risk.
By fastidiously controlling risk, you’ll be able to stay in the game. It doesn’t matter how big a shock might be or what unintended consequences play out.
And position sizing is one of my favorite ways to control risk…
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Trade Size Matters
I only ever allocate a small portion of my account to any one trade.
It’s mathematics…
If you only put 2–3% of your money into one trade, then no trade can break you. That’s true even if the market crashes.
Even if a trade goes all the way to zero, you’ve still got 97–98% of your account intact.
I learned this the hard way after blowing up my trading account several times early in my career.
But from those harsh lessons, I took this a step further…
If I was down 2–2.5% in any month in my portfolio, I’d liquidate all of my trades and start fresh the next day.
And I’d reduce the size of my positions. I’d cut my trading size in half. And if that didn’t work, I’d cut it again.
When I started making money consistently again, then I’d consider increasing my trade size.
Doing this enabled me to rack up 20 years without a losing year during my hedge fund days.
Ultimately, it led to Jack Schwager featuring me in his book Hedge Fund Market Wizards in the chapter just after Ray Dalio – the billionaire founder of Bridgewater Associates.
Schwager understood how critical my risk management skills were to my success.
Rather than trying to predict the future, I learned to manage the one thing I could control… my risk.
That enabled me to withstand all the inevitable market shocks that came.
Shocks can come out of nowhere. And even foreseeable events like a potential trade war can have unknown side effects.
That’s why you need strong risk management principles – and you have to steadfastly stick to them.
Of all the lessons I’ve learned, this one will ensure you come out swinging on the other end.
Happy Trading,
Larry Benedict
Editor, Trading With Larry Benedict