Archives of “financial risk” tag

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Universal Lessons

  
  Education
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What follows are some of the most well-known investment disciplines along with a lesson or two from each that every investor should be able to use in their own strategy.

Focused Value Investing: Buying stocks that are underpriced in relation to their intrinsic value.
Lesson(s): It’s important to invest from the perspective that stocks represent an ownership interest in a business. You get your share of corporate profits from the stocks you own and over the long-term the value of the business should be reflected in the stock price.

Quantitative Investing: Using a systematic, mathematical approach to make buy and sell decisions within a portfolio.
Lesson(s): A rules-based, objective approach to investing is a great way to take out the emotions which can trip up so many investors and introduce biases into the investment process. Automating good decisions can reduce costly mistakes.

Technical Analysis: Studying charts, past prices and volume for security and market analysis by using patterns.
Lesson(s): An understanding of the history of the financial markets is extremely important to be able to define your tolerance for risk and gain the correct perspective on what couldhappen in terms of gains and losses. And at the end of the day markets rise and fall because of supply and demand.

Index Investing: Owning the entire market/index at a low cost.
Lesson(s): Beating the market is hard. Keeping your expenses, activity and turnover to a minimum is a prudent way to earn your fair share of the market’s return over time. (more…)

The Power of Regret

  
  Education
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Everyone knows that chasing price is usually not beneficial, we either end up catching the move too late, or we get poor trade location, which makes it more difficult to manage the trade.

However, there are other forms of chasing that are just as common, maybe more common, and just as counter-productive.   As a trading psychologist I see these all the time.

Traders who are not profitable are often too quick to chase after new set-ups and indicators, or a different chat room, if that’s your thing.  Obviously, we need to have a trading edge, whether it is from the statistical perspective of a positive expectancy, or simply the confidence in a particular discretionary strategy such as tape reading, following order flow, market profile, etc.

Chasing a trade is the fear of missing out. The fear of missing out is associated with various emotions, including regret. In my work with traders and in my own trading, I’ve seen the incredible power of regret. There’s a lot of talk about fear and greed in trading, but the power of regret is often overlooked. Some of my own worst trades, and those of my clients, often have a ‘regret from missing a prior opportunity’ component. When I finally finish my book on the psychology of financial risk taking, I will include much about this overlooked but very powerful emotion.

Somewhat related to chasing a trade, is impulse trading.  They both have in common the underlying feeling of the fear of missing out.  It’s tempting for me to talk about impulse trading here, but it really deserves its own piece.

Constructing Diversified Futures Trading Strategies

  
  Education
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  • Once you reach a few million under management, hiring a research staff to improve details is a good idea.
  • Wait for momentum to build in one direction and get on the bandwagon.  Expect to lose about two thirds of the time and so make sure your winners can pay for the losers and leave enough over to cover the rent.
  • Using a single strategy on a single instrument is for people with either extreme skill or for those who simply have a death wish
  • If we put the same notional dollar amount in each trade the portfolio would immediately be dominated by the volatile instruments and not much impact at all would come from the less volatile.
  • Trend following: Buying high and selling higher
  • Non professionals tend to spend an excess of time and energy on the buy and sell rules and neglect diversification and risk

10 Trading Pitfalls

  
  Education
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  • All market behavior is multifaceted, uncertain, and ever changing.
  • “I am employing a robust, positive expectancy trading model and am appropriately managing risk on each and every trade.  Losses are an inevitable and unavoidable aspect of executing all models.  Consequently, I will confidently continue trading.”
  • Denial of loss and uncertainty is extremely destructive because it prevents us from thinking in terms of probabilities, planning for the possibility of loss, and consequently from the necessity of consistently managing risk.
  • If we view markets as adversarial we cut ourselves off from emotionally tempered, objective solutions to speculation (opportunities to profit)
  • Blind faith is no substitute for research, methodical planning, stringent risk management, playing the probabilities, and unwavering discipline
  • Depression is a suboptimal emotional state because it allows past losses or missed opportunities to limit our ability to perceive information about the markets in the present
  • We are not our trades; they are merely an activity in which we are engaged
  • Greed is linked to fear of regret, which is the greatest force impeding a trader’s performance outside of fear of loss
  • Market offers limitless opportunities for abundance
  • Trading biases prevent us from objectively perceiving reality, thereby limiting our ability to capitalize on various opportunities in the markets.

The 14 Stages Of Trading Psychology

  
  Education
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1. OPTIMISM – It all starts with a hunch or a positive outlook leading us to buy a stock.

2. EXCITEMENT – Things start moving our way and we get giddy inside. We start to anticipate and hope that a possible success story is in the making.

3. THRILL – The market continues to be favorable and we just can’t help but start to feel a little “Smart.” At this point we have complete confidence in our trading system.

4. EUPHORIA – This marks the point of maximum financial risk but also maximum financial gain. Our investments turn into quick and easy profits, so we begin to ignore the basic concept of risk. We now start trading anything that we can get our hands on to make a buck.

5. ANXIETY – Oh no – it’s turning around! The markets start to show their first signs of taking your “hard earned” gains back. But having never seen this happen, we still remain ultra greedy and think the long-term trend is higher.

6. DENIAL – The markets don’t turn as quickly as we had hoped. There must be something wrong we think to ourselves. Our “long-term” view now shortens to a near-term hope of an improvement.

7. FEAR – Reality sets in that we are not as smart as we once thought. Instead of being confident in our trading we become confused. At this point we should get out with a small profit and move on but we don’t for some stupid reason.

8. DESPERATION – All gains have been lost at this point. We had our chance to profit and missed it. Not knowing how to act, we attempt to do anything that will bring our positions back into the black. (more…)

5 Points for Discretionary Traders

  
  Education
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1)  A discipline of pre-market preparation:  All emphasize the importance of process and preparation: sticking to what you do best and being prepared for fresh opportunity–and threat–each market day.

2)  Selectivity:  All have some methods for screening stocks and focusing on a core group that offer opportunity.  Often, these screens focus on stocks that are trading actively, that show good movement, and that are setting up for directional price moves because of earnings reports, breakout patterns, etc.

3)  Patience:  This follows from the first two.  The experienced traders emphasize risk management and waiting for high quality trades, rather than overtrading.  All stress understanding the current market environment and adapting to it.

4)  Diversification:  These traders don’t focus on one or two opportunities, but look at a range of promising shares and setups and trade more than one thing at a time.  All the proverbial eggs are not in one basket.

5)  Simplicity:  My sense is that the traders are focused on understanding what is happening now, not predicting what will happen in the future.  If I had to guess, I’d say that they are talented in detecting the flow of activity in and out of shares and are riding moves as they are getting under way.  They don’t appear to be researching deep value and holding for long periods to wait for that value to be realized.

Trade Management & Psychology (One Liners )

  
  Education
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  • Let winners run. While momentum is in phase, the market can run much further than might be expected. Do not exit winners without reason!
  • Be quick to admit when wrong and get flat.
  • Sometimes a time stop is the right solution. If a position is entered, but the anticipated scenario does not develop, then get out.
  • Remember: if one thing isn’t happening the other thing probably is.
  • Flat is a legitimate position.
  • Be careful of correlations. Several positions can often equal one large position bearing unacceptable risk. Respect the potential for correlations to change—you have to deal with today’s correlation, not the correlation that existed when you put on the position.
  • The crowd is not always wrong.
  • Most trading problems come from an incorrect perception of risk. If you’re trading with an edge, the “risk” of any trade being a loser is not actually a risk at all.
  • Intuition is real, but all traders develop it. Intuition, alone, is not an edge.
  • Intuition must be trained properly. It is very easy to develop incorrect intuition due to cognitive biases and the nature of the market.
  • Mental capital is just as important as financial capital. Protect both.

Atkeson & Houghton, Win By Not Losing-Book Review

  
  Education
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 Nicholas Atkeson and Andrew Houghton, founding partners of Delta Investment Management, have written what, in the words of the lengthy subtitle, is a disciplined approach to building and protecting your wealth in the stock market by managing your risk. Win By Not Losing (McGraw-Hill, 2013) is a mix of stories about some not-so-famous investors (in fact, a few are identified simply by their first names) and an introduction to tactical investing.

The authors contend that “stock prices are influenced by oddities in human behavior that often cause security pricing to be predictable.” (p. 120) They support their contention by sharing some of their observations from the trading floor of an investment bank. Earnings momentum, for instance, can be both predictable and profitable: “the cycle of exceeding analysts’ estimates is often predictable in light of the pressures on analysts to be overly conservative.” (p. 121) And one study found that “over the 60 trading days after an earnings announcement, a long position in stocks with unexpected earnings in the highest decile, combined with a short position in stocks in the lowest decile, yields an annualized ‘abnormal’ return of about 25 percent before transaction costs.” (p. 122) (more…)

Risk, Reward and Uncertainty

  
  Education
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“From an early age, we are all conditioned by our families, our schools, and virtually every other shaping force in our society to avoid risk. To take risks is inadvisable; to play it safe is the counsel we are accustomed both to receiving and to passing on. In the conventional wisdom, risk is asymmetrical: it has only one side, the bad side. In my experience—and all I presume to offer you today is observations drawn on my own experience, which is hardly the wisdom of the ages—in my experience, this conventional view of risk is shortsighted and often simply mistaken. My first observation is that successful people understand that risk, properly conceived, is often highly productive rather than something to avoid. They appreciate that risk is an advantage to be used rather than a pitfall to be skirted. Such people understand that taking calculated risks is quite different from being rash. This view of risk is not only unorthodox, it is paradoxical—the first of several paradoxes which I’m going to present to you today. This one might be encapsulated as follows: Playing it safe is dangerous. Far more often than you would realize, the real risk in life turns out to be the refusal to take a risk.”

Life is fraught with risk. There is no getting away from it. However we try to control the direction of our lives, there are times when we fail. Therefore, we might as well accept that life is a game of chance. If life is a game of chance, to one degree or another, we must be comfortable with assessing odds in the face of risk.

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