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Book Review :Risk Management in Trading -by Davis Edwards

  
  Education
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It is a commonplace that risk management is critical to trading success. What constitutes good risk management, however, is anything but commonplace knowledge. Was VaR the number that killed us, as Pablo Triana claimed, or is it a useful, perhaps even indispensable, tool? Should risk management teams have their separate turf or should they be integrated with the trading desks? And what do you have to know to be a risk manager?
Davis W. Edwards addresses all of these questions, with particular emphasis on the third, in Risk Management in Trading: Techniques to Drive Profitability of Hedge Funds and Trading Desks (Wiley, 2014). The book is a useful self-study guide for those who aspire to become risk managers; each chapter ends with a set of questions to test the reader’s knowledge, and there is an answer key at the back of the book. It also goes a long way toward satisfying the curiosity of those who want to know just what it is that risk managers really do. It does not, however, directly address the concerns of the individual trader who wants to incorporate sound risk management principles into his business model.
After three preliminary chapters (on trading and hedge funds, financial markets, and financial mathematics) Edwards gets to the heart of the matter. He discusses backtesting and trade forensics; mark-to-market accounting; value-at-risk; hedging; options, Greeks, and non-linear risks; and credit value adjustments (CVA).
To give you a better sense of the level of the book—and so you can test your own skills—here are a few questions from the quizzes.

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Justin Fox’s The Myth of the Rational Market:Book Review

  
  Education
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Justin Fox’s The Myth of the Rational Market: A History of Risk, Reward, and Delusion on Wall Street(Harriman House, 2009) isn’t exactly hot off the press, but I discovered it only recently. It’s a fast-paced history, replete with interesting (sometimes chatty/catty) details, of theories about the financial markets from Irving Fisher to Robert Shiller.
The cast of characters is huge. I list them here to give a sense of the scope of the just shy of 400-page book: Kenneth Arrow, Roger Babson, Louis Bachelier, Fischer Black, John Bogle, Warren Buffett, Alfred Cowles III, Eugene Fama, Irving Fisher, Milton Friedman, William Peter Hamilton, Friedrich Hayek, Benjamin Graham, Alan Greenspan, Michael Jensen, Daniel Kahneman, John Maynard Keynes, Hayne Leland, Robert Lucas, Frederick Macaulay, Burton Malkiel, Benoit Mandelbrot, Harry Markowitz, Jacob Marschak, Robert Merton, Merton Miller, Wesley Mitchell, Franco Modigliani, Oskar Morgenstern, M.F.M. Osborne, Harry Roberts, Richard Roll, Barr Rosenberg, Stephen Ross, Mark Rubinstein, Paul Samuelson, Leonard “Jimmy” Savage, Myron Scholes, William F. Sharpe, Robert Shiller, Andrei Shleifer, Herbert Simon, Joseph Stiglitz, Lawrence Summers, Richard Thaler, Edward Thorp, Jack Treynor, Amos Tversky, John von Neumann, and Holbrook Working. (more…)

Lessons From Warren Buffett’s 2014 Letter to Shareholders

  
  Education
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The education of any business person is incomplete if it doesn’t include a thorough reading of Warren Buffett’s annual letters to shareholders. I often say that I have learned more from reading his annual letters than I have reading anything else. And I spend much of my days reading! That said, this year’s letter was no different than usual. In fact, it was even more jam packed than normal because Buffett spends more and more time these days focusing on Berkshire AFTER Buffett. So his life lessons are more widely discussed than ever.You should go read the letter yourself, but in case you don’t have the time I’ve jotted down some of the key takeaways:

Macro Matters. As much as Buffett focuses on the micro (specific companies) he’s always mindful of the macro. And he certainly understands that his success couldn’t have happened without riding the biggest macro wave of the last 100 years – the amazing growth of the US economy:

“Who has ever benefited during the past 238 years by betting against America? If you compare our country’s present condition to that existing in 1776, you have to rub your eyes in wonder. In my lifetime alone, real per-capita US output has sextupled. My parents could not have dreamed in 1930 of the world their son would see.”

As I always say, it’s easy to look like a great swimmer if you can figure out the direction of the current. Figure out the macro and the micro more easily falls in place.

Accounting, accounting, accounting. If you read a Buffett letter you’ll notice that it’s filled with accounting tables. I’ve stated in the past that the language of economics is accounting. It is the way we communicate the health of our economy, our institutions and our people. Buffett knows this. Buffett’s a masterful businessman because he understands the language of economics.  If you’re not well versed in accounting do yourself a favor and spend more time learning the language of economics – accounting. (more…)

Jason Zweig’s Rules for Investing

  
  Education
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1. Take the Global View: Use a spreadsheet to track your total net worth — not day-to-day price fluctuations.

2. Hope for the best, but expect the worst: Brace for disaster via diversification and learning market history. Expect good investments to do poorly from time to time. Don’t allow temporary under-performance or disaster to cause you to panic.

3. Investigate, then invest: Study companies’ financial statement, mutual funds’ prospectus, and advisors’ background. Do your homework!

4. Never say always: Never put more than 10% of your net worth into any one investment.

5. Know what you don’t know: Don’t believe you know everything. Look across different time periods; ask what might make an investment go down.

6. The past is not prologue: Investors buy low sell high! They don’t buy something merely because it is trending higher.

7. Weigh what they say: Ask any forecaster for their complete track record of predictions. Before deploying a strategy, gather objective evidence of its performance.

8. If it sounds too good to be true, it probably is: High Return + Low Risk + Short Time = Fraud.

9. Costs are killers: Trading costs can equal 1%; Mutual fund fees are another 1-2%; If middlemen take 3-5% of your cash, its a huge drag on returns.

10. Eggs go splat: Never put all your eggs in one basket; diversify across U.S., Foreign stocks, bonds and cash. Never fill your 401(k) with employee company stock.

When Strengths Become sabotage

  
  Education
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The tricky thing about playing to our strengths is that it is often our strengths, applied across situations uncritically, that can hold us back.  The dark side of strengths are sometimes called derailers, because of their potential for interfering with progress and derailing success.
Consider the following examples:
1)  The diligent hard worker who periodically burns out and fails to maintain valuable friendships and personal relationships;
2)  The process-oriented trader who develops good trading habits, but fails to innovate and expand those habits;
3)  The trader who processes information very well through teamwork and social interaction, but who falls prey to consensus thinking; 
4)  The caring manager who has great relationships with employees, but avoids conflict and does not effectively uphold work standards;
5)  The trader who is passionate about markets and learning about trading and who loses money by overtrading.
In each case, a strength carries the seed of its own undoing:  what powers us down the track can also derail us. (more…)

Super Rich: The Greed Game

  
Education, Video
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The luxurious lifestyle of those at the top of the world of finance inspires awe, disgust, and ambition. With the mind boggling salaries of the hedge fund traders in the millions and even hundreds of millions of dollars, it’s no wonder people are growing curious about how they made their money.

Robert Peston, the BBC’s Business Editor, talks with investment bankers, hedge fund managers, and top managers from private equity firms on how the super rich have made their money. It offers an eye opening look into how the big earners operate, and some of the potential consequences of their greed driven pursuit of more and more money and success. 

You are not your Trade

  
  Education
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Systems don’t need to be changed. The trick is for a trader to develop a system with which he is compatible. -Ed Seykota

Traders can make psychological mistakes when trading that can end a trading career very fast. Here are a few examples:

  • They take on more risk than they can deal with, stress takes over and they start making bad decisions.
  • They become married to a trade, they become stubborn and ignore their stop losses, wanting to be “right” they wait while losses mount.
  • Their egos take over their trading. They are more concerned about proving how smart or clever they are than making money. They begin to be more concerned with bragging about their winners than managing their losing trades. It becomes an ego trip that will not end well.
  • Their system does not match them, someone who likes fast paced action should not be a long term growth investor and someone who loves investing in growth stocks they believe in should not day trade.
  • A trader loses many times in a row so they change systems right before the big pay off. If you have a proven system trade it for the long term benefits.

Here are some solutions: (more…)

5 Frustrations of Traders & Solutions

  
  Education
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Top Trader Frustrations

  1. I cannot trade my plan!
    • You need to develop the skill to execute your trading plan under duress.
    • Use visualization exercise to see yourself successfully executing your trading plan during the day. The greater level of detail a trader uses in their visualization exercise the greater its effectiveness.
  2. I cut my winning trades too early!
    • Have profit targets
    • Take partial profits
    • Measure each day the missed profits that you could have obtained if you didn’t miss a setup, or if you didn’t cut your winning trades too early.
  3. I am not consistent with my trading
    • Establish a playbook with setups that work for you, and setups that don’t work for you.
    • Define the risk that you should take in setups based on whether they are A+, B, C setups (based on risk/reward and % win rate).
    • Track the amount of risk that you are taking on similar trades, so that the results can be properly analyzed. Risk 30% of your intraday stop loss on a A+ setup, 20% on a B setup, 10% on a C setup, 5% on a Feeler trade.
    • Do a trade review
      • Did I trade the best stocks today?
      • Did I recognize the market structure?
      • Did I push myself outside the comfort zone?
      • Things I did well
      • Things I could improve (more…)

Confidence in trading

  
  Education
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The Oxford English Dictionary gives the definition of confidence as “The feeling or belief that one can have faith in or rely on someone or something”.

In relation to trading, confidence therefore is having:

  • the belief in your ability to succeed as a trader;
  • the belief that whatever method you use for selecting entries and exits will help generate a positive expectancy;
  • the patience to wait for the right opportunities to present themselves;
  • the discipline to follow your rules;
  • the ability to keep taking suitable signals, when your criteria is met, even when suffering a run of losses.

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7 Reasons Why Traders Lose Money ?

  
  Education
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  1. Blaming outside forces for poor trading results is an incredibly destructive behavior. High frequency traders, market makers, and irrational markets, give an undisciplined trader license to make reckless trades. The less responsibility taken for results, the more destructive they can be with an account.
  2. Trading with no plan and making decisions based on feelings, is a really bad idea. Letting opinions and predictions be a guide to entries, and emotions be a guide to exits, guarantees maximum destruction of trading capital.
  3. Trade first and learn how to trade later. Traders who don’t spend time educating themselves before trading will learn the hard way, and give their trading capital to other traders as tuition.
  4. Focusing on ego and the desire to be right, instead of profitability and big losses, will quickly destroy a trader’s account.
  5. Traders that fight the trend and disagree with the actual price action will give their trading capital to those that follow the trend.
  6. Trade without discipline and risk management and a trader will be destroyed regardless of their trading system or method.
  7. If a trader doesn’t diversify their life with strong relationships, fun, peace, and health, their trading results become too entangled with their self worth. This can lead to mental and emotional ruin.
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