Risk Management

"Successful systems traders
control their level of risk."

The thing that should matter most to any trader is whether any 'deal' he
considers taking on is worth it.

That may sound obvious but generally it is completely ignored by newcomers to trading. This is not surprising since the subject of controlling risk levels never seems to be raised by any of those who provide products and services to new traders.

The question every trader must always be able to answer is: how much risk am I prepared to take for what level of return?

A trader will usually say he has a maximum risk he will not exceed, whatever the return prospects might be. He is "just not prepared to be any bolder than that".

One trader might say he would never risk all that he possesses, however good the return might be - another trader might say if the reward was good enough, he would risk all he has.

In that statement, you can see two extreme views of the same opportunity and a clear example that this is an entirely personal matter.

There are two sides to the question how much risk am I prepared to take for what level of return? There is a personal side and a system side, as follows:

The personal side involves quantifying the trader's own risk tolerance.

You would expect professional traders to have a method of doing this - and they have. If you will accept that you can produce a risk tolerance limit, then we can move on to the system side of the question:

Is this particular "set of rules" capable of delivering the return you are seeking while remaining within your risk tolerance limit?

Professional traders establish this by conducting a thorough evaluation of the system rules, on their computers.

By running extensive tests they can see how any proposed system trades the markets and whether it is capable of meeting all their trading goals.

At any risk per trade level, every different system performs in the markets in its own unique way. The trader can run tests to assess the capabilities of his system and he will only accept a system as tradable if it can show it is capable of operating within his own personal limits.

This is how traders control the level of risk they take.

Of course, the markets will not perform the same way in the future as they did in the past but by taking care to test thoroughly, the trader has done everything reasonably possible to safeguard himself from over trading.

A "bad deal" situation exists if your risk/return ratio is unbalanced against you. Your losses will then be larger than is justified by your profit prospects and the markets will gradually erode your capital.

But this is not the only problem! If your risk per trade is too large in relation to your resources, you will be over-trading, even though you may have a good deal as regards your risk/return ratio. When you're in this position, your losses will always be too large for you to recover from.

Arbitrarily lowering your risk level is not an answer either, because then you will be under-trading and missing profit opportunities. It is essential that your trading method 'balances the deal' for you.

The biggest difference between the successful commodity traders and all the 'others' is that successful traders are much more cautious when setting the amount they are prepared to risk on any trade.

 

Modus Trading
Contact David

Copyright David Bromley 2006
All Rights Reserved.