16 tips on risk management from Paul Tudor Jones every stock trader must learn

There are a handful of investors whose trading style resembles the skills of a street fighter and who are blessed with a gut instinct to quickly spot market turns.

One such legendary fund manager was Paul Tudor Jones, whose successful trading strategies have been admired and followed by many investors across the globe for decades.

Jones defined investing as a process of self-discovery. He said it may take a few failed attempts to find the right strategy that may be a good fit for an investor.

He felt as investors try to figure out good investment strategies, they are bound to face challenges and get tested at times, which would make them question their decisions.

(Masters of the Markets: Read up other investing strategies and trading tips from market greats)

“There are two unpleasant experiences that every trader will face in his lifetime, at least once and most likely multiple times. First, there will come a day after a devastatingly brutal and agonizing stretch of losing trades that you’ll wonder if you will ever make a winning trade again. And second, there will come a point when you would begin to ask yourself why is it that you make money and if this is truly sustainable. That first experience tests an individual’s grit; does he have the stamina, courage, guts and the smarts to get up and engage in the battle again? That second moment of enlightenment is the one that is actually scarier, because it acknowledges a certain lack of control over anything,” he said in an interview in the book Reminiscences of a Stock Operator.

Paul Tudor Jones is a hedge fund manager, famous for his global macro trades. He is the founder of the hedge fund, Tudor Investment Corporation, and was ranked as the 108th richest American and 345th richest in the world in 2014. He started working on the trading floors as a clerk and then became a broker in his early days.

Jones is famous for predicting the Black Monday in 1987, during which he tripled his money on his large short positions.

Jones previously served as a Director of the Futures Industry Association and played a big part in the creation and development of the association’s education arm based in Washington DC, which was later renamed as the Institute for Financial Markets.

Jones’ legendary trading strategy

Jones is famous for following a contrarian approach and strives to buy and sell stocks at turning points. He keeps on trying a trading idea until he changes his mind, fundamentally. Otherwise, he keeps cutting his position size.

Risk management is at the core of his trading style and Jones never thinks about what he might make on a given trade, but only what he may lose.

Let’s look at some of the timeless trading lessons that Jones had shared, many of which would be very relevant for investors even in these times.

1. Don’t be a hero. Don’t have an ego. Always question yourself and your ability

It is most important for an investor to learn to leave her egos out of work. As soon as one starts feeling comfortable and believe that one has got everything under control, that’s the time she would falter.

One should accept that s/he can never be in full control of the stock market. The only thing one can control are own actions and how s/he can best react to changing market conditions.

2. Be in control of your actions, and first and foremost, always protect your butt

One should be in full control of their own actions, as they are the only ones fully responsible for their success or failure in the market.

An investor should define his own trading rules and stay disciplined by sticking with them.

3. No training or classroom can prepare you for trading

One may undergo a lot of training and education on how to achieve success in the stock market, but the best lessons can be learned only by trading in the market.

No matter how good one prepared himself to anticipate every move in the market, there will be many surprises in store which they may not have predicted.

4. The most important rule of trading is to play great defense, not offense

Investors should focus most of their attention on playing a defensive strategy while trading. Most novice traders are anxious to trade all the time and try to follow an offensive strategy. They keep on looking for potential good trades and make the mistake of entering them way too soon without having a real trading plan.

Jones says one should realise that there are, and always be, a lot of great opportunities in the stock market and there is no need to rush into a trade without having the trading plan ready.

The first thing an investor needs to do is control and manage her risk and form an exit strategy for every trade. One should never risk too much of capital, because the market can spring a surprise anytime.

5. When I trade, I don’t just use a price stop, I also use a time stop.

In order to properly manage risk, traders should use stop losses in a trading strategy. Stop losses trigger ‘sell’ orders when a stock hits a certain price to protect the investor from losing too much money. Another great stop loss can be to use a time stop loss.

“With a time stop, you can set a specific time frame for a move to happen. And when it doesn’t, you cut your position no matter if you’re taking a loss, or are in a small profit. The stock isn’t acting the way as you expected. So there is no reason to keep your money in it,” he says.

6. Learn from your mistakes to improve yourself and grow into the future

Investors are bound to make tons of mistakes in their trading journey. But the good thing about making mistakes is that it gives one an opportunity to learn from them.

7. You always want to be with whatever the predominant trend is
It is natural for investors to always want to follow the overall market trend while trading in stocks. So Jones says one should not argue with this trend as the odds are greatly in their favour while trading in the same direction as the market.

8. After a while size means nothing

One should have a clear trading strategy and follow her trading plans, irrespective of the size of her investment. One should begin with a small amount at the start, so that she can learn how to handle a trading account after which one can slowly start increasing the size of the investment.

9. At the end of the day, your job is to buy what goes up and to sell what goes down

To be successful in trading, all traders need to do is buy stocks that will go up and sell them at higher prices. In the same way they should short stocks that are falling and buy them back at a lower price. Traders should keep things simple and understand that this is their main objective for which they need to learn how to identify the stocks that are going to make a move.

10. Every day I assume every position I have is wrong

It is human nature to search for confirmation after making a decision, which is called a confirmation bias, and in trading, this means traders would start looking for information to confirm a trade.

But Jones advises traders to do the opposite and assume that the trade that they are planning to execute is wrong and should look for evidence against it. “Only when one can’t convince herself that she is really wrong on a position should she become confident that she holds a good trade,” he says.

11. Losers average losers

Investors should not buy more into a stock when the price has dropped after their initial buy. Shares may be cheaper at that moment, but it mainly means the stock has moved in the opposite direction than what was expected. So one shouldn’t average down on a losing position and instead, do the opposite and average upon their position that shows a profit. “When your analysis is proven right, time to back it up with more of your capital,” he says.

12. Adapt, evolve, compete or die

Traders should spot their mistakes and adapt accordingly. They should always be meticulous in trading actions, so that they know what led them to making a bad trade.

“When you know where it went wrong, you can adapt your approach the next time. By doing that, every trade you take will evolve into a profitable one,” he says.

13. When I am trading poorly, I keep reducing my position size

Most traders feel the need to bounce back after a losing streak by trading bigger position sizes. But Jones feels when traders are on a losing streak, it is better for them to not risk more money. They should cut down the size of their positions for a while and avoid taking risk until they get back in sync with the market.

14. The most important thing is how good you are at risk control

Risk management is one of the key areas to learn as a trader. When things are going their way, traders should give their trade the time to develop and let them ride and increase profits. On the other hand, when things are not going as anticipated, they shouldn’t hesitate and sell their position as soon as possible.

“Don’t worry that you’ve made the wrong decision by selling your position when things don’t look that good. You can always buy back when everything looks strong again,” he says.

15. Look for tremendously skewed reward-risk opportunities

It is important for traders to analyse the risk-reward ratio for every trade. With every trade, traders should make sure that the odds of profiting from it should outweigh the odds of losing money.

16. Have an indefatigable, undying and unquenchable thirst for information

Traders can’t find mispriced assets unless they have an investing edge and that edge can come from better information and knowledge. They should strive to gather more information and knowledge which can help them trade better and achieve success in the long run.

(Disclaimer: This article is based on various interviews of Paul Tudor Jones)

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