The key to good risk management is first understand the key weaknesses in both methodology and psychology. My tendancy is to over trade, always wanting to be in the market. Therefore the strategy is in 3 parts, short term, medium term and long term over three separate asset classes, providing exposure most of the time. Overtrading also leads to more losses and losing streaks. In order to over come this problem, development of a mechanical entry system is used (discussed in trading methodology) to reduce trade frequency along with an aggressive reduction in position size after two or more loses in a row.
The basic management profile is in three stages, first and foremost is survival in other words don’t lose money.
Account ‘Survival’ Stage - Usually starts at the begining of the year after Christmas New year break,in January or Februray. After an extended break away form the markets it is important to get back in touch, with what is going on. This phase always kicks in during times of uncertanity, high volatality, and losing streaks.
The Basic concept is set stops at the appropriate technical level, ie. the absolute extreme price that proves the trade idea wrong. Risk no more than 0.5% of equity, from entry to stop. Always get out earlier if its obvious you were wrong, and expect slippage. If two loses in a row occur halve the risk ie. 0.25%. Increase back to original risk level after a target has been hit, or confidence is restored.
Secondly is to build the fund using the profits built up in the first stage. If at any point during the calendar year profits fall below starting equity + 5% then revert back to ‘survival’ stage.
Account ‘Building’ Stage - Begins once equity has risen over +5%. Risk no more than 1% of equity, from entry to stop. Always get out earlier if its obvious you were wrong, and expect slippage. If two loses in a row occur halve the risk ie. 0.5%. Increase back to original risk level after a target has been hit, or confidence is restored. At +10% of equity increase to 2% and continue the process until a maximum of 5%. So at +25% risk no more than 5% of equity, from entry to stop. Always get out earlier if its obvious you were wrong, and expect slippage. If two loses in a row occur halve the risk ie. 2.5%. Increase back to original risk level after a target has been hit, or confidence is restored. Above 25% use a percentage of the profits on top of the 5% risk, with a maximum of 50% of profit + risk at anytime.
Thirdly once the fund is built up to a satisfactory level over a number of years, the objective is to minimize risk and trade at a level that is psychologically comfortable.
Account ‘Comfort’ Stage – Eventually trade size and account size, reach a level that is comfortable. In other words a string of loses are not stressful, because the fund is large enough to cope with the draw down, and the quarterly return is sufficient to support the lifestyle objective. It’s important to reach a level where risk per trade is 1 – 2% of equity, and never more, and size is reduced in the event of a losing streak. At this stage 50% of profits are withdrawn from the fund and 50% are re-invested each quarter.
For the purpose of this blog trade risk will be defined in each post as RL 1 (ie. entry to stop, risk level 1% of equity). Note if not stated the default is 1%. Three accounts are reported as 100% of equity for each asset class, Foreign Exchange, Commodities, Equities. Providing equal weighting. (ie. 100 + 100 +100 = 300% total fund).
Foreign Exchange is run under a short term strategy, usually hours to days occasionally weeks.
Commodities are a medium term strategy, weeks to months, occasionally longer.
Equities are a long term strategy, months to years, with a ten year horizon.
0 Responses to “Risk Management”