Implementation of Risk Management according to me is quite simple and doesn't require much thought. However to derive a process could take time and research and could depend from individual to individual.
share your style of managing Risk on your individual trades, trading capital and on your total portfolio i.e. for each stage what has been your process, has it been different for each stage and how you implement it, pit falls during implementation and control /audit mechanism, if any.
Step I:
1) Decide on Portfolio Allocation: Portfolio allocation starts with defining Financial Objectives : How much money you would need and when? Your assets, liabilities, income and expenditure. This is a different subject altogether but still ultimately one (even a trader) has to start here.
(a) Variable (positive / negative): Equity, Real estate, Gold, F&O (Directional positions)
(b) Variable (positive but unsteady returns) : F&O (multilegged strategies primarily using Options)
(c) Fixed (positive) : FDs, NSCs, PPF etc
2) Decide on time frame to adjust Protfolio Allocation : Could be quarterly, half yearly or yearly. Depending on your portfolio performance, income from other sources/job/inheritance etc
Step II: Here I am zeroing on the aggressive part of portfolio allocation - Trading in Options:
1) Risk = Uncertainty of DESIRED outcome
2) Desired Outcome = (a) + (b)
(a) Primary Desired Outcome = For position taken at Time T0, price CHANGES in favour of position taken at Time T1
(b) Secondary Desired Outcome = MAGNITUDE of price change from P0 (at Time T0) to P1 (at Time T1)
Hence at Time T0 and Price P0, we need to define both, T1 and P1.
For a one market, one instrument, one trading plan trader (like me) T1 is sacrosant (FIXED), P1 is the only variable.
P1 is defined before trade initiation. P1 is defined both for positive outcome and for negative outcome.
Eg If I am buying Nifty Options @ time Time T0 at price P0 (Rs. 100), and defined is P1 is Rs. 95 (worst drawdown) or Rs. 107 (best outcome), my Risk is Rs. 5. (Rs. 250 for one lot).
If my trading capital (which is PART of my Portfolio) is say 10 L and I decide to RISK 2% per trade (this % is decided at the end of each week for the next week depending on the performance in the week gone by. The range of Risk / trade is between 1% to 4%), then I would buy 80 lots of Nifty Options.
At time T1, the probable outcome of Option prices could be:
93 : Exit fully (2.8% loss of trading capital : 80 x 50 x (-7) = -28000)
95 : Exit fully (2% loss of trading capital : 80 x 50 x (-5) = -20000)
97 : Exit fully (1.2% loss of trading capital : 80 x 50 x (-3) = -12000)
100: Exit fully (0% loss of trading capital : 80 x 50 x 0 = 0)
103: Exit 75% (0.9% profit to trading capital : 60 x 50 x (+3) = +9000)
106: Exit 50% (1.2% profit to trading capital : 40 x 50 x (+6) = + 12000)
109: Exit 25% (0.9% profit to trading capital : 20 x 50 X (+9) = +9000)
You would notice that if the price at Time T1 is less than 100 I exit fully and on some occasions the loss could be higher then anticipated 2% in this case if I exit at 93. But this margin of error in my risk management is acceptable since I exit at Time T1.
Secondly you would notice that at price levels > 100 (i.e. 103, 106, 109) I have partially exited. But these exit % are NOT RANDOM.
If the price is > 100 at Time T1, then this T1 becomes new T0 and the current price say 103 become new P0. From here I would again calculate new P1 (both worst drawdown and best outcome scenario) and accordingly adjust the quantity.
Step III:
Treat your profitable trade and non-profitable trades seperately. The MOMENT I close my profitable trade, the profit made on the trade flies off out of my trading capital account and rests in a different account which is my Variable - steady profit funding account, where I use multilegged Options strategy with low risk and average returns as the time frame used in these strategies is quite larger (almost 2 to 3 weeks or sometimes till near month expiry). Most common strategy is Covered Call, which may be covered in detail in some thread on this forum. Also sometimes, strangle or straddle or simply deep OTM call/put writing, depending on the market condition. HOWEVER here too, my RISK management techinique is quite similiar to the one mentioned in step II of trading naked options. i.e. P0 at T0 and defining P1 at T1. i.e. fundamentally though the strategy has changed as the funds are from different account, but RISK management is still the same.
Now as I keep withdrawing the profits from my trading capital account, and continue trading eventually my trading capital would tend to cease some point of time as there are some loss making trades which eats the trading capital. Yes this is what could happen eventually, hence with each passing period, my trade size reduces as my trading capital reduces. Though my Trading capital could tend to be zero it doesn't happen, WHY?
Because, remember adjustment in Portfolio Allocation (Step I), which I do every calendar quarter end. Hence basically I have to live with my trading capital for a period of 3 months, the better I trade I get more quantity to trade and then quantity decreases gradually. Profits keep going out.
When Portfolio Allocation adjustment happens at the quarter end, Trading Capital is top-uped up STRICLY on the basis of trading performance in the last quarter, hence if I started with 10 L trading capital which was reduced to 5L in three months and has generated profit of 8 L then I may be entitled to top up to 10 L or even higher depending on my overall Portfolio performance in the quarter gone by. Alternatively instead of 8 Lacs if the profit generated was 4 Lacs, then my trading capital can be top-uped to a max of 9 L it could be generally be lower viz, 8 L or 7 L as performance was NOT ACCEPTABLE.
STEP IV:
At the quarter end review and portfolio allocation adjustment, majority of the incremental profits generated by Trading, Variable (steady profit) strategy are allocated another account which funds conservative investment account. The investment made through this account essentially follow simple 100 days / 200 days moving averages which are held for longer period of time.
STEP V: THE PURPOSE!!!!!
Why do we do all this? i.e. trading, portfolio allocation, risk management etc. Do we want to grow our wealth to Eternity and leave it for someone after we are gone. NO.
I am working as a portfolio manager (or better still - a hedge fund manger) then I should be paid for my services. This is what precisely I do when I levy PMS charges every quarter end and take out that amount from the Portfolio to my 'personal account' for my personal consumption. The charges I levy are similar to any PMS charges which includes, fixed and performance linked payouts over a hurdle rate of return every quarter.
p.s. :
1) To maintain simplicity here I have not covered Portfolio performance parameters, weekly volatility (standard deviation) of portfolio etc. These are the parameters against which I evaluate my performance every month and do course correction. My remuneration is linked to some of these parameters.
2) All the above mentioned steps of Portfolio and trade management are documented in black and white for reference and remove conflict of interest.
3) For all different strategies and aspect of my wealth management, I have given them names and there are really funny names which makes it very easy to implement them.
4) As all actions (tradewise) are documented. I conduct a monthly audit of these documents and for actions inappropriate or outside the defined parameters of my scheme of managment, penalties are imposed, which include ban from trading for a period, cut in remuneration etc.
'Execution' (or say implementation) is one area which has taken many years and money for me to tame. Over a period I have managed to create a system which is devoid of interference of various functions of Trading and portfolio management.
Having read various books on related subjects, the basis of this system is dervied from a very simple and a small book titled - Six Thinking Hats : Edward de Bono. You can find jist of this small and wonderful book on the net.
The concept is wearing one 'hat' a time and thinking only on those lines what is indicated by the colour of the 'hat'.
Trading, like any other corporate business comprises of various 'people' who are instrumental in running the business (read trading here) smoothly.
In any corporate, you have the core decision making team comprising of the MD, the senior management team - the think tank. Within The think tank you will have Product Development, Risk, Compliance, Legal guys etc.
Then you have a set of field managers, who are implementors/executors whose job is to just sell the product.
In the intermediary you also have Process team, who defines the company's process policies etc and finally the HR team too.
If you define Trading as a "BUSINESS", you will have to relate and allocate all the above roles to different 'people' of this business. But the irony is there is only one indiviudal - "I" who has to do all these roles constanly, day in day out and this is where we fail in initial years in this business as there is a constant overlap, haphazard, random thinking and interchaning of roles which we are not able to define and regulate and ultimately blaming our 'emotions' to the losses we accumulate in the initial years.
Coming to specifics, I run a virtual Corporate entity in myself.
The decision making, implenting, process, operations, risk, compliance, legal and HR is all rolled in ONE person. The only difference is the way all these 'different' people function. And this is where the concept of 'Six Thinking Hats' comes. Each individual function is taken 'INDEPENDENTLY' by physical objects (small toys) which are placed in front of me at a time, which directs to think only on and through that respective roles. Once the outcome is reached it is written on the scrible note and passed on the next role and so on.
I know it may be sounding weird but it works, one can get into a specific role mindset by making the environment look like that and physical objects makes it more easier. Also documenting the outcome helps the cause. For e.g. if the 'decision making team' makes a buy call, defining time frame, drawdown, payoffs etc. it is written on the note and then passed on to the 'execution team'. The role of this team is to just execute as per the instructions written in the note. Post this, they would write a note stating 'job done'. This is just one example which I have stated. This is how the entire machiney works, which includes, operations team, whose job is to ensure that systems, net, broking house matters are taken care without hassles. The accounting team takes care of contract notes, bills, bank statements, charges etc on weekly basis for storage. Any special observations by these 'teams' during their course of action are noted and taken up at the review meeting which is generally on a weekend.
Sounds funny... but it works as the thinking, execution, etc is compartmentalised with no overlap. It is nothing but Keeping it Simple (here it is not necessarily Short, but who cares if this is what works for me well)
Be focused
Keep things simple
Follow Kaizen - continuous improvement
Adapt to change (Again a very small book - "Who moved my Cheese?", would help)
And most importantly, keep smile.
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Thoughts on Money and Risk Management. Money Management is simple if we create a rule and strictly follow it with extreme discipline. Everything will become confusing if we do not maintain extreme Discipline. I follow a simple Money Management technique, and stick to it, at any cost. I made a Risk to Reward Ratio at 1:2. I maintain 5 p.c. Stop Loss and 10 p.c. gain. I never put in more than 10 p.c. of my equity in one counter. When there is a loss in one counter, I take a gap of 10 days to re-enter provided signals are good. I only invest those money which if lost doesn't change my lifestyle. I lost money on various occasions, but only to my Risk to Reward Ratio principle, but I am still comfortable trading due to the fact that I do make lot of winning trades also. Its my R-R ratio that helps me stay in trade.
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Secrets of Top Trading Performance-
Much of a trader's early education is concentrated on strategies and market analysis. But what are the necessary ingredients for peak performance? What are the tools for both mastering the mental side of the game and busting out of the inevitable slumps that can occur along the way?
There are several key common ingredients when you are performing your best, no matter what the field.
EXPECT success.
It begins initially with your self-talk. Do you get down on yourself when you make a mistake? - or do you say to yourself - next time I will do better because I have great trade management and am a superior trader! Be your own best motivator and believer in yourself. Positive Self Talk leads to positive BELIEFS. If you believe you can do something, you WILL eventually find a way. When you have a positive belief system that the eventual outcome will be OK, then you are more mentally and physically relaxed. You then have better concentration, which leads to smoother execution, which of course leads to peak performance.
Be Prepared
All of the above factors deal with external factors and internal belief systems. Now let's get down to the DOING part! Every trader should be prepared before the markets open because they already did their homework - right?! One of the most impressive points in the Rogue Warrior book was this veteran navy seal's obsession for being totally prepared for Mr. Murphy! There was always a backup plan for everything and this is what kept him alive. Prepare your daily game plan by looking for both new setups and preparing strategies for managing existing positions.
So, assuming that you have done your daily homework as a trader, the next step is to learn how to get into the groove. There is no better tool for this than having routines and rituals. Pre-market rituals help calm the nerves, get you into a rhythm, and also help to turn off the logical part of your brain - the part that wants to over analyze everything.
Here is another helpful factor: A healthy body keeps a healthy mind. EXERCISE! This gets oxygen to the brain and keeps the blood flowing. How can you expect to be a peak performer when you are eating junk food and going through insulin swings? Or perhaps you drank too much wine the night before or are jittery from drinking too much coffee. How can you concentrate well if you are not getting a full decent night's sleep? Sure, most of these are minor factors but they can all add up to major bumps in your performance. One moment of sloppiness can lead to forgetting to place stops or letting a bad trade go too long. Then when damage is done, your confidence gets chipped away. You must treat your confidence level as something to be protected. Good habits will keep your confidence level high. Once you have good habits, it will allow you to increase your trading size.
Goal Setting
* Flexibility. Be flexible - if what you are doing isn't working, change what you are doing!
* Confidence. When down, get a little rhythm and confidence going. Don't worry about being too ambitious.
* Concentration. Stay with your game. Don't let outside distractions bother you. They take energy and break your concentration.
* Know Yourself. Match your particular strengths to the type of market conditions.
The battleground isn't the markets but what's within you!!!
And on that last note, remember that ATTITUDE is everything. How you frame out an individual experience or event will affect your success in the long run. Do you see a trading loss or bad draw down period as a major setback, or do you see it as a learning experience from which you can figure out how to be on the RIGHT side of a trade instead of the wrong side the next time around. Many great traders use periods after draw downs to go back to the drawing board. Some of the best systems and trading ideas have come after periods of adversity. What incentive is there to learn and improve ourselves when everything is smooth sailing and we are fat and happy? But when times are tough, that is when we can rise to the occasion and prove that we can overcome any OBSTACLE set down in our path.
So many great athletes have been able to come from behind when they are down because they have learned how to seize that one opening or opportunity and CONVERT. They latch on to the tiniest shift in momentum and milk it for all it is worth. Latch on to that next winning trade and convert. The first small moral victory is the first step towards reaching the top of Mt. Everest. And if you keep making small steady steps, you will eventually reach the top. Sometimes for a trader, the greatest feeling in the world can be making back those losses, no matter how long it takes, because once you have done that, you realize you can do anything.
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read Ryan .............his site smarttrading.com........if u think to master MM
Be a student of FRM.......financial risk management
for simple learning KISS on risk management/money management.......be a member of paid site
www.masteroftrading.com........where good pro teaches .
USE stator-afm as software if u like.
................I have heard that trading is 70% psychology, 20% money management and 10% how you trade. If you are 'guessing' that the problem is money management you may be missing a more important reason.
Suggest that you review previous trades, successes and losing streak and see what you did or how you thought differently. Perhaps over trading, guessing, not having firm plan, not following plan etc etc.
What do you think you did wrong money management wise?
focus of money mgmt is - SURVIVAL. As a trader, we can survive to fight the battle on next day, only when we control the amount that we are going to loose.
We got to set the rules and follow.. (if we don't have the rules, then there is no question of following them). It is not just matter of knowing this number in our head.. but I prefer to keep it in writing so where and also refer to them regularly and monitor them during the market hours.
In my trading, I have various loss limits as % of my trading account size.. i.e.
- Risk per trade 1%,
- Risk per day - 4%,
- Risk per Week - 8%,
- Risk per month - 10%.
At the start of month I calculate these number and then they are reset only on next month begining.
You can have different % here. But higher the number, difficult it gets to recover the loss. In my approach even if I am down 10% in a month, I can easily recover in next month.. but if I am down 30% in a month (i.e from 100, i have come down to 70), then I will need a RoR of 45 to 50% to recover.. which is not practical in a month. So, I keep fighting for 2/3 months just to get back my loss.. Not a good trading loop where I want to be in.
The Must rule for me is to stop trading for as soon as any of the loss limit is hit.
If I have 4 loosing trades in a day, my trading day is over. If I have 1 4% lossing day, and next day again I loose 4 trades, I am on holiday for a week. No more trading, no fighting with mkt to recover my loss.. Psychological impact of losses on our decision making is very different topic.
I follow following MM rules in my trading :
1) The initial risk in any trade should not exceed 1% of the trading capital...with adds it should not exceed 1.5 %
2) Max risk at any point on all open daytrading positions should not exceed 3%
I will also suggest the following to follow in the loosing streak :
1) Trade small till you get on the winning streak and get back your confidence because loosing streak not only dents your trading account but it dents your confidence,clarity of thoughts,judgement etc
2) You must learn to hold on to your positions when they are going in your favour...also add to your profitable positions...this is the key to trading profits....no amount of brilliant thinking will do that for you ....it is your adding and sitting with profitable positions which will make enough money in your succesful trades much more than your losses in loosing trades....and this applies to daytrading as well you can have 2-3 profitable adds during the day.
3) Wait for proper set ups to develop before you take a trade...this is particularly necessary in loosing streaks..
Calculate Risk and Reward before entering every trade and write it down on paper. This would help you to define clear, technical stops/targets and most of the time, I have changed my mind when I wrote Risk/Reward ratio on paper.
Try to preserve what you have earned, does not matter how little they are, on day to day basis
Keep survival alone as your trading goal, you will be doing great money management. Once you have seasoned, you will automatically trade for big profits. Till that time comes, don't push yourself. Be slow and just learn to survive.
........... in trading , u dont have to be genius , but a copy master. Copying what is done already and try to protect u from already proven failed system IS major part for in journey of a trader.
Next is what fits u.when u get by using a system ,however peculiar may it look by others, if its give u consistent money atleast for 1 yr ,in real time trading,........that should be your edge,Now with discipline stick to that system in proven market condition.
AGAIN prepare another system .......not for its betterment, but which may work in future changed market condition.
Trading is not a place of innovation,already more than 120 yr enough experiment has clearly put in black & white.........what works