Exists A Robust Risk Management System”
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.