Ancient man had no risk management. Everything was left to ‘fate’ and the whims of the gods. Because ancient man felt that he was merely a victim of circumstance he did not see a need to plan for the future. Therefore, he had no future. In his book Against The Gods: The Remarkable Story Of Risk, Peter Bernstein plots out the history of man’s discovery of the law of probabilities and risk management. Suffice it to say, economic progress seems to run parallel with man’s ability to discover, quantify, and manage risk. Risk and reward are two sides of the same coin. One is not present without the other. You cannot receive the reward unless you are willing to take the risk and you cannot expect to keep that reward unless you learn to mange that risk. It is imperative to master both subjects if you expect to be successful in any endeavor, especially the arena of investing/trading.”
Archives of “risk and reward” tag
rssRisk and Reward
Before placing any trade, a strategic trader must always know and identify the maximum risk exposure for the trade. Once the risk is identified, it should be compared to the possible profit target. If the profit target does not justify the risk exposure, the trade should not be taken. It does not make any sense to risk a dollar to earn a penny. One of the common mistakes that cause traders to consistently lose money is that they fail to let their winners run. They quickly close out their trades as soon as they become profitable. While no one can argue against taking a profit, consistently taking profits that are not consistent with the desired risk/reward ratio ultimately leads to a net loss. Once a stop is hit, it immediately eradicates the small profits of three or four trades that were prematurely closed. It is hard to leave your money on the table, but there are ways to move up your stops and use a trailing stop to allow you to stay in your trades to realize your designated target.
Once a trade is placed, prices will always fluctuate; that’s the nature of the auction process. Rarely will a trade directly navigate to the profit target without a retrace. This is where paper trading comes into play. It allows a trader to watch, learn, and record how long it takes to reach a profit target and whether the risk/reward strategy that they are using is in fact feasible and workable.
Self-Assessment
* How many of your trades today (or this week) had an explicitly defined risk and reward?
* How many of your trades today (or this week) did you execute according to the defined risk and reward?
* How many of your trades today (or this week) were based upon clear market patterns and a clear identification of how the market was trading?
* How many of your trades today (or this week) were placed out of fear of missing a move? Out of frustration following a loss? Out of boredom in a slow market?
* How many of your trades today (or this week) would you place again if you had the same circumstances?
* How many of your trades today (or this week) came from advance planning and preparation?
* How many of your trades today (or this week) were sized properly, given your level of confidence in your ideas and your desired risk management?
* What did you learn today (or this week), and how will you put that learning to work tomorrow (or next week)?
* How did you feel about your trading at the end of the day (or week)? Proud? Disgusted? Regretful? Satisfied?
* What can you do tomorrow (or next week) to feel proud of and satisfied with your trading?
RISK
“Ancient man had no risk management. Everything was left to ‘fate’ and the whims of the gods. Because ancient man felt that he was merely a victim of circumstance he did not see a need to plan for the future. Therefore, he had no future. In his book Against The Gods: The Remarkable Story Of Risk, Peter Bernstein plots out the history of man’s discovery of the law of probabilities and risk management. Suffice it to say, economic progress seems to run parallel with man’s ability to discover, quantify, and manage risk. Risk and reward are two sides of the same coin. One is not present without the other. You cannot receive the reward unless you are willing to take the risk and you cannot expect to keep that reward unless you learn to mange that risk. It is imperative to master both subjects if you expect to be successful in any endeavor, especially the arena of investing/trading.”
Hard Realities for Traders
* If you don’t save a good portion of your earnings in successful years of trading, you won’t last during the less successful years;
* If you don’t have a solid nest egg of savings to support you while you’re learning trading, you won’t survive your learning curve;
* Everyone has a passion for trading; if you don’t have a passion for learning to trade, take a pass on financial markets and find the field of endeavor that offers intrinsic reward;
* If you’re living for your trading, you won’t make it trading for a living. Other things need to sustain you in the lean times, particularly the things that are more important than markets;
* The ratio of time spent working on your trading to time spent actually trading is predictive of long-term career success;
* In any performance field, the percentage of participants who can sustain a living from their craft is under 5%; always have a Plan B;
* No one can make you successful as a trader if you lack the requisite talents and skills; a mentor can, at best, help you make the most of the talents and skills you possess;
* Even if you are very successful as a trader, your annual income will be a fraction of your leveraged portfolio size;
* Your risk and reward will always be proportional: count on drawdowns of at least half of what you hope to make in markets;
* Psychology alone cannot make you a successful trader, but it can make you an unsuccessful one;
* Quiet markets reveal the best traders;
* Over time, your risk-adjusted returns are more valuable than your absolute returns;
* Trading is a business and, as such, must always adapt to changing market conditions;
* If you can’t make money consistently when paper trading, you won’t be successful when your capital is on the line;
* If someone promises you trading success, keep a close eye on your wallet.
16 Points for Day Traders
Accepting risk may cause losses, but accepting unfunded liabilities and negative skew can bankrupt us. Use models not to predict, but to create a range of possible outcomes for which we can plan. Markets follow cycles based on the perceptions and actions of its players, and one can gain alpha by using these cycles to manage risk and reward. Markets SEEK efficiency, but offer tremendous opportunities while traveling from inefficiency to efficiency. Both people and machines have flaws, so use the best attributes of each for peak performance. Forecasting is necessary but should be timid in nature, while action is not always necessary but should be BOLD on the occasions when conditions dictate it. Risk management is made more complete by searching for information that differs from your analysis rather than by that which confirms it. Successful practitioners turn mistakes into assets by generating learning experiences and continuous improvement. Remember to distinguish between clues that are necessary, vs. a complete picture revealing a group of necessary AND sufficient measures. Markets can be generally explained 95% of the time, but extreme events happen much more than a bell curve would indicate…using options guarantees that we’ll survive fat tails and grab positive skew. We are certain we DON’T know what will happen, so the best approach is to figure out what WON’T happen and blueprint accordingly. Diversification reduces risk most of the time, but we assume all assets are linked and eventually correlate. It is critical to have both a brain and a gut; the ability to find an edge, and the fortitude to trade it aggressively. Profitable opportunities are best entered in the earliest stage of latent power being converted to energy. Too soon is a waste of capital, too late involves too much risk. Virtually all long-term strategies are positioned to simply ride the tailwinds of rising prices. It is imperative to have methods to protect us from both headwinds and crosswinds to avert disaster. Treat volatility as a psychological risk to be managed into an ally, not as a financial measure of risk to obsess over. |
Risk And Reward
- Risk and reward are not necessarily correlated. After all, if riskier assets could always be counted on to generate higher returns, then they wouldn’t be riskier. Therefore, volatility can’t be “risk.” This is why so many academic models of the financial markets end up leading us astray. Instead, Marks says that risk means there is a high probability of more uncertain outcomes. You might have seen the chart below from Marks depicting this concept that basically shows that the distribution of uncertain outcomes increases as you take more risk. This is a vast improvement on the idea of the efficient frontier that simply implies that more risk will generate more return, which often leads people to think that they’ll do better simply by owning stocks “for the long run” or something like that.
Oaktree Capital
Marks notes that making predictions is incredibly difficult. Instead, it’s better to focus on ways in which we can improve our probabilities of good outcomes. Many times in the financial markets we’re better off knowing what we don’t know.
- We’re all going to be wrong a significant amount. One of the keys is ensuring that we don’t make significant mistakes.
- You have to learn second-level thinking, which involves thinking differently and better.
Trading Wisdom from Richard D. Wyckoff
“You can learn from this how to develop independent judgment, so that you need never ask anyone’s opinion or listen to anyone’s tips, or take anyone’s advice. You can so train your judgment that you will know just what to do and when to do it. When you are in doubt you will do nothing.” –Richard D. Wyckoff
Wyckoff was talking here about trading. He was talking on the subject of studying the markets to determine how they operate. You will find developing your own trading strategy/method can be the most rewarding and challenging experience of your lifetime. You need to be comfortable with the risk, before you are comfortable with the reward. There is an age old saying, ‘If you can’t stand the heat, then stay out of the kitchen.’
As traders, we are exposed on a daily basis to the trading concepts of risk and reward. Personally, my own reward to risk tolerance took some time for me to feel comfortable with it. How much do you want to risk on each trade, and how much are you looking to make at a minimum?
Are you at its minimum profit objective going to make more money than you risk? So if you would take two trades, and one would win and the other would hit your stop loss, would you turn a small profit on your trading? Obviously, the goal of every trader should be the three general trading rules. (more…)
The Two Trading Problems
The old saying indicates that fear and greed are the emotions that dominate markets.
Eliminating emotion from trading is both impossible and undesirable. The “feel” for markets possessed by the best traders is a form of emotion; Antonio Damasio’s writings on this subject are must reading.
When we become very anxious or frustrated, however, our assessments of risk and reward are impaired: that is the enduring message of behavioral finance research. Regional cerebral blood flows no longer activate those executive parts of the brain responsible for planning, judgment, and decision-making. Rather, we regulate our motor activity as part of “flight or fight”. In the flight mode, we flee from risk and inhibit trading decisions. This leads to immediate safety, but also missed opportunity. In the fight mode, we confront risk and activate trading decisions. This leads to the relief of taking decisive action, but also poses increased possibilities of loss.
With market volatility at record levels, it’s not unusual to experience outsized losses when trades are wrong. These losses place a figurative magnifying glass on our flight or fight responses, activating stress modes at exactly the times we want to be most deliberate and planful. (more…)
Which type of trader?
Which type of trader?
Please which one of the following belong to you?
there are many type of traders, an awareness of the varieties allows you to avoid the pitfalls.
THE DISCIPLINED TRADER.
This is the ideal type of trader, you take your profits and loses with ease, you focus on your system and follow it with discipline.Trading is usually a relax activity,you appreciate that a loss does not make you a looser.
THE DOUBTER.
you find it difficult to execute at signals, you doubt your won abilities.You need to develop confidence.Perhaps you should paper trade.
BLAMER
All losses are someones else ‘s fault, you blame bad fills, your broker for picking the phone up to slowly , our system for not being perfect, you need to regain your objectivity and self-responsibility.
VICTIM
You blame yourself, you feel the market is out to get you, you start becoming superstitious in your trading.
OPTIMIST.
You start thinking it’s only money , ill make it back later. you think all losses will bounce back to profits, or that you will start trading properly tomorrow.
GAMBLER.
You are in for the trill, Money is a side issue. Risk and reward analysis hardly figure in your trade, You want to be a player, want the buzz and excitement.
TIMID.
You enter a trade, but panic at the sight of a profit and take it far to soon, Fear rules your trading.