Managing Risk

Very few traders truly understand the inherent risk in their strategy. That goes for systematic traders as well. Simply taking backtests and saying that a worst case drawdown is four consecutive losses because the results say so is wrong.

Your worst drawdown is perhaps eight to ten consecutive losses. Do you have the capital to manage that normal event? If not then you are putting your system at risk.

Do you know what an allowable drawdown is? If not, you will never know when your system is acting normal or something has gone wrong.

Managing risk is more than saying "today I will only allow $250 in losses" or the often misunderstood rule of only trading 2-3% of total capital. It is more than running a simple Monte Carlo simulation. Managing risk must become an integral part of system design and studied every day a system operates.

Managing risk means knowing when to trade and when not to trade. It is one of the most important facets of trading, unique to every style and approach.

And yet the vast majority of retail traders simply choose to ignore it.