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Book Review -The Risk of Trading by Michael Toma

 Michael Toma’s The Risk of Trading: Mastering the Most Important Element in Financial Speculation (Wiley, 2012)

If I had to choose the two key sentences in this book they would be: “Risk management is not limiting losses. It is the art of maximizing profits for a given optimal risk.” (p. 173) That is, contrary to commonly-held views, risk management goes far beyond placing stops or calculating position size. It also goes beyond the purely mathematical, even though it would still behoove traders to be familiar with the seminal works of Ralph Vince (The Mathematics of Money Management, 1992) and the many books and papers that followed in a similar vein.

Toma, a corporate risk manager and the author of Trading with Confluence, offers a simple, math-free analysis. (Well, here and there a spreadsheet comes in handy.) He is at his best when discussing how to track performance.

One recommendation that I consider especially sound is that the trader track opportunity risk. “Auditing ‘opportunity risk’ is equally as important as measuring your actual trades. … In all the risks associated with trading, I find opportunity risk, whether in the form of unexecuted trades or pretarget exits, to be the difference between traders who reach that much-talked-about top 10 percent in the profession and those who remain in the novice pool, struggling to keep their heads (and P&L) above water.” (p. 126) If you were presented with a valid trade setup in your plan and you sat on your hands, track that trade. Are you actually skilled at overriding your system or should you, as Toma argues, take advantage of every opportunity that your plan presents?

Toma recommends that every trader construct his own key performance indicator (KPI) dashboard. Keep it simple, sticking to five to eight measurable items initially. And keep it balanced in scope. “The indicators should represent a balanced monitoring synopsis of performance, compliance, and business metrics. A common gap in KPI programs is that it is completely dominant in trade result metrics. A measure that detects rule breaking is far more indicative of trading success than a KPI that measures current win percentage over a small time period.” (p. 133)

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