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Title: Risk Management
Author: John Moore
Successful traders develop an objective trading plan and discipline
themselves to
let their plan govern their trading decisions. When developing a plan,
try to KEEP
IT SIMPLE!! Whether employing the use of fundamental, technical, or
statistical
research; or a combination of all three, one must be cognizant of it's
limitations.
There is no such thing as a "system" or "methodology" that is accurate
100% of
the time.
There is much hype in academia, and also recently in the industry,
which involves
the use of statistics in calculating "probabilities of profit." One
must recognize,
however, that statistics are merely one of many tools that a trader can
use when
determining whether or not to take a position. Be very cautious in
relying totally
on these complex mathmatical models. Betas, gammas, thetas, vegas, and
deltas
are excellent buzz words and do "assist" in the decision-making
process, but
successful traders whether cognizant or not, understand that these
econometric
models do, indeed, have their own limitations. For example, how can
variables
such as GREED, HOPE, and FEAR be quantified? Everyone knows that these
emotions are prevalent to varying degrees in the day to day
determination of
prices, yet econometric models group them all in to one variable and
call it the
"unexplained." This is because they are impossible to quantify. Thus,
when
considered in the context of being one, and only one, of many different
analytical
techniques, statistics can be a useful tool. Outside of this context,
one must be
aware of the inherent risks which exist when attempting to analyze a
"three-dimensional" problem in only two dimensions!
No matter how a trading plan is constructed, all plans should include
the following:
1.Determine a price objective
2.Determine a time horizon
3.Predict the PATH of the future price move
4.Determine the maximum $ risk exposure
5.Make sure the $risk falls within the scope of the plan
6.MANAGE THE TRADE
Clearly, 1, 2, 4, and 5 are fairly simple and straightforward
processes. The most
difficult part of trading is TRADE MANAGEMENT. Trades are very easy to
initiate, very difficult to manage. A trading plan should always
govern the
decisions a trader needs to make WHEN the market does NOT perform
exactly
as the trader anticipated. There are many who can forecast future
prices with a
fairly high degree of accuracy. There are few, if any, who can
accurately predict
the exact PATH the market will travel in reaching a target price
objective. This is
why a plan must be flexible and include objective decision-making
criteria which
allow the trader execution ability WHEN the market does NOT perform as
anticipated! This is the essence of risk/money management which is
characteristic
of all successful traders, yet absent in most.
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