Ex­ists A Ro­bust Risk Man­age­ment Sys­tem”

Dalal Street Investment Journal - - SPECIAL REPORT -

Let us ex­am­ine some prag­matic and com­mon sense-based risk man­age­ment meth­ods. Risk con­trol is as much an is­sue of com­mon sense as it is of com­plex rules and math­e­mat­ics. Most of this chap­ter shows how var­i­ous rules, mea­sure­ments, and lever­ag­ing tech­niques can re­duce risk for both dis­cre­tionary and al­go­rith­mic trad­ing; how­ever, suc­cess­ful traders have ap­plied com­mon sense, with­out com­plex for­mu­las, for a long time. Some of th­ese suc­cess­ful prin­ci­ples are:

1. Only risk a small amount of to­tal cap­i­tal on any one trade. The to­tal amount risked should al­low you to com­fort­ably sur­vive a num­ber of losses in a row. No trade should ever risk more than 5% of the in­vested cap­i­tal.

2. Know your exit con­di­tions in ad­vance. There should be a clear exit cri­te­rion for every trade, even if the ex­act loss can­not be known in ad­vance.

3. Large prof­its mean large risk. If the av­er­age prof­its or av­er­age losses are too large rel­a­tive to the in­vest­ment, then smaller po­si­tions should be taken.

4. Exit a trade quickly. Exit a trade as soon as you rec­og­nize that it has gone wrong. Don't try to man­age the loss. Many floor traders be­lieve that the smartest trader is the first one out.

5. Don't meet mar­gin calls. Ex­pe­ri­enced traders be­lieve that a mar­gin call is an ob­jec­tive state­ment of a trade that's gone wrong, or a sys­tem that is not meet­ing ex­pec­ta­tions. It is a time to re­view trad­ing per­for­mance rather than in­vest more. Liq­ui­date your worst po­si­tion first when light­en­ing up. The prof­itable trades have proved that they are trend­ing or per­form­ing prop­erly; the los­ing ones have proved they are not. Stay with the good po­si­tions and liq­ui­date the worst.

7. Be con­sis­tent with your trad­ing phi­los­o­phy. If you are a trend fol­lower, then keep losses small and let prof­its run. You can­not be a trend fol­lower by tak­ing prof­its when­ever they oc­cur.

8. Be sure the trad­ing pro­file is com­pat­i­ble with your risk pref­er­ence. You can­not fol­low a strat­egy that takes risks that are un­com­fort­ably large. Be sure that pro­file is agree­able to you.

9. Plan for con­tin­gen­cies. Noth­ing ever goes as planned, and you must be pre­pared for in­fre­quent but im­por­tant ex­cep­tions, such as a price shock. Do not be un­der­cap­i­tal­ized.


While we con­clude, it is ev­i­dent that the risk man­age­ment tech­niques work con­stantly be­hind-the-scenes and we need to en­sure con­stant ap­pli­ca­bil­ity of th­ese meth­ods. Just like be­hind every suc­cess­ful man there is a woman, it would not be wrong to say that be­hind every suc­cess­ful trader or in­vestor, there ex­ists a ro­bust risk man­age­ment sys­tem.

We need to en­sure that such risk man­age­ment sys­tems re­main per­pet­u­ally in place in our life as an ac­tive in­vestor or trader.

Newspapers in English

Newspapers from India

© PressReader. All rights reserved.