Welcome visitors and regular readers! I continue to translate useful materials, which are not found on open spaces of the Russian segment of the Internet. Not once noted on the blog that many traders lose money because of the increased risk, it is a very common mistake. This article will look at risk management in trading "cold" look, and will greatly improve your results!
The hero of today's post became Ed Seykota. In the special needs no introduction, Jack Schwager made him famous, including interviews in his book - Market Wizards. One of my favorite books, others can see in the article: "8 best books on stock trading, I have read!". It was digress :-). Ed Seykota - eminent trader to find his biography is not difficult, so I will not be reprinted hundreds of times already written, let's try to understand the risk management!
Transfer.
Risk
Risk is the possibility of loss. Suppose that we have some stocks, as there is the likelihood of lower prices, we are at risk. The very action is not a risk, as well as the loss itself. Risk - is the possibility of loss. When trading shares risks are inevitable, and the best thing we can do is to learn to manage them.
Risk Management in trading
Risk management is the calculation and control possible losses. Calculation and control of risks, increase or decrease positions is the main activity of risk managers (the main task of the trader).
For example, consider a coin toss
Take a coin toss if there is an equal probability of heads or tails. This experiment will help to visually examine the risk management concept.
Probability of an event is the ratio of the number of events for all possible implementations. Thus, if the coin falls eagle 50 times out of 100, then the probability of an eagle will be 50%. Note that probability varies from 0 to 1 (0 = 0.0%, 1.0 = 100%).
denote the following conditions for the experiment: (1) start at $ 1000; (2) will always put on the loss of an eagle; (3) We can supply any amount that is available; (4) if the roll tails, we lose the bet; (5) If the eagle falls, we get 2 times more than the set; (6) coin toss random process, therefore the probability of an eagle is 50%. This experiment is similar to trading.
In this case, the probability of a favorable outcome is equal to the probability of loss of an eagle, or = 50%, we will win half of the tosses. The relations of our payoff of 2: 1, that is, we get twice that set. Our risk is the amount of money you can lose in the next toss. In this example, the ratio of risk to reward remains the same, we can only change the bet value.
In more complex games such as real trade, the percentage of winning trades and the amount of winnings can be changed repeatedly, with changes in the market situation. I think traders spend a lot of time to change the probability of a winning trade and increase the profitability of trade, as a rule, it does not give results. The risk of a single parameter, which is to focus your attention. We could simulate more complex processes, such as trading, let's look at an example of the table. The figure below.
Transfer.
Risk
Risk is the possibility of loss. Suppose that we have some stocks, as there is the likelihood of lower prices, we are at risk. The very action is not a risk, as well as the loss itself. Risk - is the possibility of loss. When trading shares risks are inevitable, and the best thing we can do is to learn to manage them.
Risk Management in trading
Risk management is the calculation and control possible losses. Calculation and control of risks, increase or decrease positions is the main activity of risk managers (the main task of the trader).
For example, consider a coin toss
Take a coin toss if there is an equal probability of heads or tails. This experiment will help to visually examine the risk management concept.
Probability of an event is the ratio of the number of events for all possible implementations. Thus, if the coin falls eagle 50 times out of 100, then the probability of an eagle will be 50%. Note that probability varies from 0 to 1 (0 = 0.0%, 1.0 = 100%).
denote the following conditions for the experiment: (1) start at $ 1000; (2) will always put on the loss of an eagle; (3) We can supply any amount that is available; (4) if the roll tails, we lose the bet; (5) If the eagle falls, we get 2 times more than the set; (6) coin toss random process, therefore the probability of an eagle is 50%. This experiment is similar to trading.
In this case, the probability of a favorable outcome is equal to the probability of loss of an eagle, or = 50%, we will win half of the tosses. The relations of our payoff of 2: 1, that is, we get twice that set. Our risk is the amount of money you can lose in the next toss. In this example, the ratio of risk to reward remains the same, we can only change the bet value.
In more complex games such as real trade, the percentage of winning trades and the amount of winnings can be changed repeatedly, with changes in the market situation. I think traders spend a lot of time to change the probability of a winning trade and increase the profitability of trade, as a rule, it does not give results. The risk of a single parameter, which is to focus your attention. We could simulate more complex processes, such as trading, let's look at an example of the table. The figure below.
This table contains 6 possible outcomes of the transaction, such a system can be applied in real life.
But now let us return to our example of the coin, this experiment has enough features to illustrate the many risk management systems. The more complex the situation will look at later.
The optimal rate
In our experiment, there is a constant probability of winning is 50%, the constant risk / profit = 2/1, and we will always bet on falling eagle. To find the optimal risk management strategy, we need to select a constant rate. The same question is raised by traders when trading stocks, how to open the volume of trade? Good traders know that they can not greatly alter the percentage of winning trades, but the main issue is the choice of the size of the deal! We start the game with $ 1000!
Intuition and the system
One way to determine the size of the bet is a premonition. We could listen to the inner voice and put 100 $.
Choosing bid based on intuition rather popular, as happens in most cases, but this approach has several problems: need constant attention, concentration in each transaction, in addition, a lot depends on the mood, psychological state.
Selecting the size of the bet can be passed on to the system. The system is a specific sequence of actions, which is designed to determine the size of the bet. Advantages of the system to an intuitive approach: (1) it is not necessary each time to think, (2) rates are constant, consistent, and, most importantly, (3) we will be able to perform historical simulations on the computer to optimize our system.
Despite the universal acceptance of the fact that the system has clear advantages over intuitive, very few use a risk management system in trading, a system that is possible to describe and test on your computer. Our example is a coin is quite simple, so we can come up with some bid management system. Moreover, we will be able to test and optimize our methods, and stop at its best.
Fixed rate and a fixed percentage of capital
It is necessary to choose the system for measuring the size of the bet. Each time put the same amount, regardless of whether we won or lost before that - one way to streamline the size of the bet, it is a system. It is a system with a fixed rate. For example, we will put $ 10. Note that the initial capital of $ 1,000 can be changed so that $ 10 would be a bad choice for the rate, it is true, and to reduce the capital and to enlarge.
To solve this problem, we consider a different approach: we are always risking 1% of the capital. In our case, 1% of $ 1,000 equals $ 10, as in the first system. But changes in equity, and changing size of the bet.
There is one interesting fact, when the risk management system in trading by a fixed percentage: as the size of the bet is always equal to 1% of the capital, it is theoretically impossible to reach a total loss of all the money. In practice, the situation is quite different.
Testing
Let's check our risk management system, we will test them and see the results. Imagine that we flip a coin 10 times, fell 5 heads and 5 tails. See the results in the table.
But now let us return to our example of the coin, this experiment has enough features to illustrate the many risk management systems. The more complex the situation will look at later.
The optimal rate
In our experiment, there is a constant probability of winning is 50%, the constant risk / profit = 2/1, and we will always bet on falling eagle. To find the optimal risk management strategy, we need to select a constant rate. The same question is raised by traders when trading stocks, how to open the volume of trade? Good traders know that they can not greatly alter the percentage of winning trades, but the main issue is the choice of the size of the deal! We start the game with $ 1000!
Intuition and the system
One way to determine the size of the bet is a premonition. We could listen to the inner voice and put 100 $.
Choosing bid based on intuition rather popular, as happens in most cases, but this approach has several problems: need constant attention, concentration in each transaction, in addition, a lot depends on the mood, psychological state.
Selecting the size of the bet can be passed on to the system. The system is a specific sequence of actions, which is designed to determine the size of the bet. Advantages of the system to an intuitive approach: (1) it is not necessary each time to think, (2) rates are constant, consistent, and, most importantly, (3) we will be able to perform historical simulations on the computer to optimize our system.
Despite the universal acceptance of the fact that the system has clear advantages over intuitive, very few use a risk management system in trading, a system that is possible to describe and test on your computer. Our example is a coin is quite simple, so we can come up with some bid management system. Moreover, we will be able to test and optimize our methods, and stop at its best.
Fixed rate and a fixed percentage of capital
It is necessary to choose the system for measuring the size of the bet. Each time put the same amount, regardless of whether we won or lost before that - one way to streamline the size of the bet, it is a system. It is a system with a fixed rate. For example, we will put $ 10. Note that the initial capital of $ 1,000 can be changed so that $ 10 would be a bad choice for the rate, it is true, and to reduce the capital and to enlarge.
To solve this problem, we consider a different approach: we are always risking 1% of the capital. In our case, 1% of $ 1,000 equals $ 10, as in the first system. But changes in equity, and changing size of the bet.
There is one interesting fact, when the risk management system in trading by a fixed percentage: as the size of the bet is always equal to 1% of the capital, it is theoretically impossible to reach a total loss of all the money. In practice, the situation is quite different.
Testing
Let's check our risk management system, we will test them and see the results. Imagine that we flip a coin 10 times, fell 5 heads and 5 tails. See the results in the table.
Please note that both the system in the first roll earn $ 20. On the second cast with a fixed rate system loses $ 10, and a system with a fixed percentage of the capital loses 1% from 1020 $ or $ 10.20.
Take a look at the results of both systems are almost identical. But over time, the system with a fixed percentage of capital provides an exponential growth, and fixed-rate system - linear, so first surpass the second. By the way, the results depend on the amount of loss eagle and tails, and The order of the loss does not matter, you can check it.
This is the beginning, my dear friends, Ed Seykota material presented in some detail, so I can not fit everything in one post, wait for the continuation!
Take a look at the results of both systems are almost identical. But over time, the system with a fixed percentage of capital provides an exponential growth, and fixed-rate system - linear, so first surpass the second. By the way, the results depend on the amount of loss eagle and tails, and The order of the loss does not matter, you can check it.
This is the beginning, my dear friends, Ed Seykota material presented in some detail, so I can not fit everything in one post, wait for the continuation!
