Managing Risk

We all know about managing risk. We all know plan your trade and trade your plan. We all know about to our winners run. We all know the importance of exiting trades for a loss when things are not going as thought. Hell we know a lot. So one question.

Why do most of us fail miserably at trading? Is it because there is a difference between knowing and understanding. Between knowing and executing? Possibly. Here's another reason. When it comes to risk management, it's just too boring. It's not exciting. It doesn't use "cool" things like RSI, MACD, Stochastics and more.

So what exactly is this really boring concept called managing risk? Well, it's a lot of things. It's not just honoring stops. It's actually a lot more than that. It's not just controlling things like revenge trades, doubling down when you should be going flat, etc. Though those are part of it.

Rather than lecture on what I define risk management as, I'll share my own approach regarding the subject. As much as I can. Because a big chunk of my time and system development is spent on the subject.  Far more on that and less on signaling.

One aspect of managing risk is measuring it. Not just how much you can lose on one trade.  Rather the inherent risk in a strategy. And to have that, you need data. Lots of data. Depending on trade frequency you may need years of trade data. Which if you don't have the ability to backtest, you likely don't have any. Sorry, but a few months of trade results are not sufficient. You need a statistically valid sample. A population size that covers more than just a short term market fluctuation.

Once you have that data you need to use a tool like Monte Carlo simulation. Simply stated, it takes your data and randomly scrambles it. Often making what you thought was your worst drawdown even worse. Then you need to apply some statistical measure to those results. From which you can truly get a sense of the cost to trade per lot. A broker who requires $500 to trade one-lot of ES is not your capital requirement. Rather that value is "zero." You need to add on top of that the capital per your Monte Carlo simulation to truly determine the cost to trade per lot.

Other aspects of my own risk management include knowing when to trade and when not to trade. Nothing is left to a game day decision. Tomorrow Janet Yellen will speak before congress. She begins at 10AM, the same time my system will begin trading. I already know, based on a lot of study, that in the long run it makes sense to trade through her testimony. But I also know when ISM manufacturing is released on the other hand to not trade. I've done all my homework.

When a trade goes on, within 200 milliseconds I have an OCO, protective collar if you will, in place. Risk is pre-defined. And to further help matters, I don't watch the trade. No chance of me doing something stupid and moving a stop further away. Or getting greedy with a limit order.

I can go on but I'll spare you. I have spent a lot of time on the subject of managing risk. But I think I've covered it enough.

After all, we all know about managing risk. Right? Question is. Do we practice it.

 

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