Throughout my trading career, I've met with various more experience traders who took me under their wings, in this episode, I will share the successful traders ability to 'stay in the game", how to take deliberate actions for improvement and costly mistakes to avoid as a trader
In the part two of risk managing, it’s a compilation of highlights from my past trading experiences all of which are relevant to managing risk and staying in the game.
My hope and compiling this best of risk management part two is that you have a go to reference but times when you need to sharpen your risk controls as well as draw your attention to some elements of risk management that may have gone unnoticed.
The first question from beginner traders is that do you have any core principles around managing risk .
The original thing I’m saying about Say you might be going to risk ultimately 10% of that trade and you are going to be comfortable with that 10% risk, you need to keep tousled in the game as long as possible and then consider the win loss ratio. You got to expect you are going to lose many times so this needs to be factored in the 10% risk , you could actually have some ideas of how to trade the markets because you’re over that and anything else you are feeling negatively is probably a big sign that you’re doing something wrong.
And this is a terrible cycle against you, it’s dangerous to get into this cycle. It’s that DO NOT average into a losing position and when I was trading for a hedge fund, we have a list of rules and one of them is that I would have a strong sell on what is weak and I love that rule because to really captures what moves you have to not fall to believing that as perceived perception of pricing is too high or too low and not releasing that highs and lows always being tested and the markets could be forming new highs and lows.
You see, the market is constantly in the state of flux and there’s no saying what’s going to happen in the future so you need to know that when I stop aggressively or not before we just buy at a low price and then I was going to buy a bit lower because there’s no definition of what that means.
Great risk management principles is when you can still think objectively even when we have big down days and not seeing it rattle our confidence that you’re seeing a trader still be able to walk up office head high with a big smile on their faces and you knew for a fact that guy was down a massive amount on the day, I was talking about tens of thousands of dollars and then again to you that right mindset that you didn’t have to be a professional trader to tell that and then turn up the next day like I’m gone, I’m fucking scared I’m scared to kick them out so you know you do it to execute teh trading plan so it makes you stronger. That’s the one thing I learnt that we made a big difference for me personally is understanding the support or understanding that there’s no such thing as a free trade.
I was talking about to always look for free trades and deviate from your trading plan which is a big problem because I found that I would keep moving your stops to break even in the early days of my trading is comforting. And it is comforting to know that your risk is eradicated on the trade by just thinking that you found id didn’t work because the markets keeps coming back and take me out and then going in the direction. When I was sitting next a g huge trader that took me onto his wing and we actually poke about this and I said you know, “ I just got stopped out at break-even again and that damn mark is moved you know, I thought it would and he said to me , Why are you moving to break even and I said I “ I bought this, you know, this level and you know the stock has moved up 26 cents and I don’t want to take the news on it at that point.
He said to me “look if you buy support right which is why you got in that trade and it goes off 26 cents dollars and it comes back to the support level, what are you doing.
You’re scratching the trade and puking it right into support because you don’t want to lose money. That doesn’t make sense. You’ll be hit out and your focus on the P&L and he said to me “trade the fucking market” you know don’t trade your P&L and it was a really , really powerful lesson for me.
And that epiphany has helped me tremendously over the years in increasing my consistency and locking in large profits as the markets move in my favor. I’ve seen people that maybe go in a predetermined price say $40 and the stock moves $.90 cents and they say, well I’m moving to break even now to make this a free trade so I’ve got nothing to worry about.
Thinking nothing to worry about is not a strategy. How about thinking about that you are risking 90 cents to make 10 cents and people make a huge mistake of not realizing that risk reward evolves during the trade. It’s not a static concept that you have it and you trade onset so you can start a trade and we’re going for a sweet one with the risk and reward points in the trade where you will have a massively diminished trade and the odds is now against you so this was again something that I learned from a very large trader is basically not to trade my P&L and by constantly looking for the free trade and remember , the risk and reward evolves and it was a very very powerful lesson I learnt in my career of trading.
The next question from Wall Street Secrets reader is how do you determine whether or not the trade has a worthwhile risk to reward ration before entering the trade. Do you have a profit target or how do you judge that before you get into that trade.
So whenever I get into when I’m looking at before placing a trade, I have an idea of where I’m looking to book prints and I have a fair idea of where I’m wrong on the trade, what is the maximum risk. So that the remaining thing I got to think about is the risk and reward ratio. Is it good enough to merit taking the trade now. I’m guessing a lot of trader in this respect are taught to for a two to one or always go in for a three to one ratio or what have you.
And that is good, don’t get me wrong the higher that you reward-to-risk ratio is, the better it is or I wouldn’t dispute that but what I would say is that it’s dependent on the trade and it is dependent on your risk reward ratio combined with your strike rate.
If you have a high strike rate you don’t need a high risk and reward ratio to make money. So I’m aware that I can get away because of my strike rate with a risk and reward ratio of 1 to 3 and I don’t like going lower than 1 to 3 although I’ve worked out over time I can get away with it than 1 to 3 but I generally I’ll look for 1 to 2 or higher now. Obviously, you want to get the ratio as high as you can so one of the things that I do is to try to establish very early on in the trade is this.
How many should be a key question because a lot of traders get into a trade find that managing the trade is the hardest thing and a lot of time, managing ups and down is hard because you don’t know that if you have an expectation of where you think it is going to go, you just see the mark is lighting and to react to that is a bit over done to the upside or downside.
You could have an idea of what I try to do is I try to have two types of trades. I have those where I feel that the market is poised from a higher time frame to make a big move and then I’m gonna get in on a lower time frame at the 4 hours or 60 minute and try and answer that trade and sometimes for the whole day. Sometimes even for longer to try and capitalize on a bigger move but the other type of trade is where I will literally play from one level to the next in a week so my Hari support and trade up to the next level and as you would expect I’ll find trades where I will run onto a higher timeframe will be the ones that payout in terms of giving me a higher risk reward ratio but that would only got a one to one risk reward. I would even told to take a two to one risk reward trade and I’m still gonna take that trade but I’m going to make my stops tighter to make my reward target bigger but you are completely ignoring the structure of the market because you’re trying to impose the risk and reward on the market and to me that’s crazy because you got the market, and the market doesn’t give a shit about your risk and reward ratio.
So if you’re not trying randomly impose a risk and reward ratio, think again that’s where a lot of people got wrong.
The next lesson I learnt from the trading floor especially having access to someone more experienced about risk that traders maybe often ignored or don’t even think about or just plain simply don’t ask themselves. Well, I guess the first interesting question, one and this is the definition of the question because ti be a risk manager, you focus more on what there is to lose instead of what there is to gain. Or do you focus on both was somewhat equal weights.
Most traders leave a lot of money on the table on the upside and how can take we take some of that money off the table. I think this is an interesting question.
There are types of risk that are either hidden or unknown ( or described by Nicholas Nassim Taleb as black swan risks). I guess I’m partly answering this question in a timely manner because of the coronavirus pandemic causing the markets to drop more than 20% in a few days and we’ve recently even benefited from positive black swan events like these.
Like what Nassim Taleb described in his book, you should have basket of insurance and a basket of options that benefit from black swan events. Like the movie the big short when you bleed a little over time and when it comes to a large event, the returns can be enormous. Most people do not have this and it is kinda like entrepreneurship, if you look at the Amazons and the Ubers of the world, those tech companies bleed a little over years and eventually make the big bucks when the companies say, go public.
We humans are not evolved to think like that. It’s much more comforting to get a consistent small gains over time and tolerate blowups. Ponzi schemes operate on this very premise.
So how do we think about this sort of thing as a risk manager and how do traders need to walk up to these unknown black swans events and protect your capital. What people usually miss is something that’s so fragile traders so even think about.
I think one of the main things about trains is that that it teaches you to be more disciplined knowing that you could put on a trade on Wall Street and it might not go you way so that you’re up. It’s up to you what you do with it from there, do you add on the position or do you take a loss.
You also get to reconfigure your trading and see why that is not working in your favor. There are times you just get disappointed with those choices you make and you know timing is everything so you may have the right reading and you put out the runtime and then you’re on. Then you gotta figure out where you go from there.
One of the things as a trader to put on size and that’s what really turns the tide for me. During a winning streak, I sometimes got too comfortable putting on trades because I was making more money for everybody but for me I felt that with me and I knew my risk that I was very comfortable and I think being comfortable with the risk you are taking is one of those stepping stones of being a successful trader.
Actually If I can completely divorce myself from money I know that’s hard to do. If you can get away from the money and just focus on the market and making good trades, you’ll be distracted by those things. I’m a big believer in trading your own money, if you want to trade someone else’s money, just be really careful especially it’s your family’s money or grandma’s pension money. One of the things that happens when you start trading with a live trades is to really enjoy the challenge of the hill and climbing up the hill.
Why risk management is king and why gambling isn’t such a dirty word. Over the year we have been modeling and managing risk for our hedge fund and that entry is an important thing for most people and another thing is the bankroll and risk management that truly matters. So let’s use the case of the casino as an example. When you’re taking risk of any kind that you’re playing a game of change you know a lot of work that we’ve done has been aimed at treating markets as if the random there is absolutely not random at all.
It’s nothing about the markets in the first place because what we found is that the very interesting things can be discovered if you start in and have to study them, and you start thinking about markets as if they’re random the way to kind of understand how can it be created through models so if you think about a casino and a typical casino, the whole bunch of different games with table games and slots and they have curious betting limits across those games and there are all games of chance.
The Easton why I’m bringing this now to you because it is really important if you knock on 100 door in your neighborhood and you say I’m doing a server what you think, you know a very large percentage of people will have image of this guy like it’s no better on betting on black and stuck in Vegas.
But if you go back to the next door and you say how would you like to own a casino, now all of a sudden everybody said it would be fun on some level, what’s the difference at the casino isn’t gambling with teh player on every hand that they play. What we’re talking about here is the edge and it will be be the mathematical edge casinos lose all the time in various bits and various games and that is because of the edge they've built into the game that case the casino
it's actually the structure of the games and to a lesser extent the structures some of the players but at the end of the day we doing is grinding out .
And to do something about this hands-on way to me about how can I control the deck so we talk about being released important in the context of this conversation that's what we're talking about
It doesn't really necessarily have to mean anything you know it's not realistically to trade in a single market for example in today with very few occurrences and expect a replicated entirely from the risk model you need to have an advantage on risk management you're having the ability in the market that is unique to set your own payouts
Nobody knows casino lets you walk up and say I love to play this game and I'm totally comfortable with your you know what you are 1% or whatever it is based on the structural advantage you have in a game but here is the deal you only have to give me 3 to 2 mm Blackjack
Or when you give me to chips and anytime I'll give you one shirt because no one's ever going to give you those odds because they can't win right that's what I'm talking about market
nobody says to you that nobody tells you how to create your bet instructions so you know you if you want to do you want to risk three points and every time you get well your your risk math is inverted as we call it so yeah you get a couple couple was 43 handles of peace you know you're going to have a lot of 1.10 you going to have to call back from Oran do that but it's your choice not what you can you can say I don't care if I ever 20% win rate of 15% win rate whatever not going to get after accepting wind till I made me in tens times my money or whatever the number is you're probably not gonna like it psychologically but it doesn't mean for a second that that's not the best application it's going to make you the most money typically what makes you feel the best as a discretionary trader
his never what's going to get you the money it's always you know where we say you know being being being a trader and general discussion leaving discretionary trader is about managing discomfort and it never gets any different over the years.
When I was in my early years of trading, I’m always always kept thinking I'm not making the right decision you know it's just something that you have to settle in and realize and make sure that it's not influencing you
You should react and how you should manage your position or put on a position at all so that's really what we're talking about what we talked about the importance of that stuff but if your focused on me know when the syndicated lines up with this and that's what you think you're going to you gonna make your money.
It's not hard and an even if it is temporarily if that kind of inefficiency exists in the market for long so the market will eventually find it and it will render it obsolete so you know you really have to be focused on how to manage your money it in or not only had of risk manager but it's not going to be going to have to adapt to changes.
Most people that pointed at result they don't want it to be adaptable they don't want it that they want these I go to the beach and a year from now I'm just print money and that's the dream that a lot of people get sucked into and I'm sorry to say there is just no light at the end of that time on the subject of risk management here so is there anything anything in particular that you have noticed amongst Traders on a retail level that they often don't think about all consider when it comes to risk and I guess lastly why do they have a tough time being profitable I think there's a way to sort of define your Max pain.
I was going to trade but it really all that alone isn't really think about you definitely have to have those components of striving to 22 really understand what your typical average win is what your average losses and that’s a very complex issue because some people treat all in all strategy some people scale-out only but not in some people scale in but not out some people scale in and out and depending on what the strategy is all these things or theoretical percentage so in other words you use it as a divisor to create your trade size
so you know somebody trades I don't know you know the treating 12 stock trades in the years for example when the maximum staff at the every uses is 33 % so it's 50 box of the year so it's $150 well then he want to buy that hundred $50 into your equity in the account and understand what it is on a percentage basis so if you lose that trade what percentage of your equity are you going to lose and then the so now you understand so let's say it's 1% so you're risking 1% of your equity theoretically all is that enough why don't know how many occurrences you gonna have how frequent do you treat you treating 8 times a day with trading once a day or you know how many over the course of Advanced occurrences do you have and how does that play into it
So you might be asking the next question, what sort of developing a risk model of it's based on having a typical maybe one two three events Max per day trading this one market and all of a sudden start reading 20 times a day and think that it's not impacting it is it's ok I got my stuff and all of that stuff really matters and I think the other thing that we see it again this goes back to the psychology of the try to mitigate pain which is very common in general trying to too hard to achieve a little result or the effectiveness of the strategies solely on its linear ability to produce results on every single series of portraits
I want to have three wins and one loss when we can get lost when when when I'm not even joking people really can't we had stuff like that and you have to accept things like you know starting to stop over analyzing every individual trades that doesn't mean anything it only seems like it does and what's happened with that really has nothing to do with anything so you want to stop analyzing well if I lost this trade it must mean that I made a mistake and if I win this trade it must mean that I'm pretty smart right unfortunately a lot of people think that way and the truth is neither is true it's just you win some you lose some.
Your trading have to become very very comfortable with that and so people start thinking about blocks of trades and we say for a typical day trader you shouldn't be analyzing anything statistically evaluating risk model until you've got a months worth of Trades because the idea of what ever happened today in your loss tomorrow
And get back to the drawing board you know I gotta change my model this is I can't believe I like fully staffed this model is broken but you don't know that it's just you know it's free of inconsequential but so it just these things are what feeds the back to the drawing board back to the drawing board back in the keep going back to drink from a well that doesn't have any water in it and then eventually they lose interest in the typical relationships that right now
The typical average retail account attrition is inside of 3 months to the average person interested in active trading to open the count doesn't last 3 months so it doesn't mean they all of their account it just means that for whatever reason and a big number of them are from the people that we've experienced and interacted with from that world are are definitely ending up in that in that line of failure is not because the Builder account out or because they don't have what it takes to be a trader it's because you know their focusing on entries hyper analyzing each other both individual trade and using that ammo to quantify success or failure go back to the will try to create a new model rinse repeat print 40th backtests repeat so that's it I mean and it's not most of them never even get to the point where we could have a discussion about what's wrong with the risk model out of developer test because they're start dinner tracks