Hello, friends! On the night of Ulyanovsk, which is probably why I was drawn to emphasize "a couple of lines." But seriously, the present position will complete a series of articles about risk management from Ed Seykota (my translation). If you have not read the previous ones, I advise you to begin right now: 1, 2, 3 parts.
Now, let's understand, what are the methods to assess risk in trading? There are several, each has its own advantages and disadvantages, however, now know everything themselves. The methods are more suitable for otsenkiinvestirovaniya in stocks, but many are applicable to all types of trading.
Transfer.
Measurement of portfolio volatility. Sharpe Ratio, VaR, Lake ratio, stress-testing.
The diversified portfolio is difficult to track individual methods, systems, they merge and become part of the overall performance. For this case there are methods of risk assessment fund as a whole.
In 1966, William Sharpe publishes a paper in which he first mentioned factor, later named after him. Sharpe Ratio, S, is the ability to compare tools with different performance and volatility.
S = the average yield (D) / standard deviation (D) - Sharpe ratio, which
D = Rf-Rb - the yield differential, where
Rf - return of the fund (account, the portfolio);
Rb - yield benchmark.
Over time, there are different variations of the Sharpe ratio. For example, selecting a certain period for a benchmark or a full reset. Or quadratic Sharpe ratio, which includes the variation of yield, instead of the standard deviation. An important point in the use of Sharpe Ratio (English style) is that it does not differ positive and negative volatility, so the score in some cases, does not correspond to reality.
The VaR, or value at risk measure is another popular method. As a rule, the VaR indicates what percentage of the drawdown will not be achieved in a given time interval with a probability of 95%. Disadvantages of this approach is that (1) the historical data can not accurately predict the future volatility, and (2) always remains a 5% probability that the settlement level drawdown will still be achieved. Large drawdowns can occur quite suddenly and quickly, in such cases, the VaR-method does not work.
Another way to estimate the volatility index is Lake Ratio. Lake - Lake, translated to English now understand why this name. Imagine a graph tool necessary to us (action trading account portfolio performance) showing peaks profitability and drawdown. Now imagine the rain, walking in the mountains or hilly terrain, where each depression filled with water. Pofantaziruet and "drag" it to the chart, admire, as water fills each drawdown (figure below). The total water area characterizes the magnitude and duration of the drawdowns.
risk assessment with the help of LR
Transfer.
Measurement of portfolio volatility. Sharpe Ratio, VaR, Lake ratio, stress-testing.
The diversified portfolio is difficult to track individual methods, systems, they merge and become part of the overall performance. For this case there are methods of risk assessment fund as a whole.
In 1966, William Sharpe publishes a paper in which he first mentioned factor, later named after him. Sharpe Ratio, S, is the ability to compare tools with different performance and volatility.
S = the average yield (D) / standard deviation (D) - Sharpe ratio, which
D = Rf-Rb - the yield differential, where
Rf - return of the fund (account, the portfolio);
Rb - yield benchmark.
Over time, there are different variations of the Sharpe ratio. For example, selecting a certain period for a benchmark or a full reset. Or quadratic Sharpe ratio, which includes the variation of yield, instead of the standard deviation. An important point in the use of Sharpe Ratio (English style) is that it does not differ positive and negative volatility, so the score in some cases, does not correspond to reality.
The VaR, or value at risk measure is another popular method. As a rule, the VaR indicates what percentage of the drawdown will not be achieved in a given time interval with a probability of 95%. Disadvantages of this approach is that (1) the historical data can not accurately predict the future volatility, and (2) always remains a 5% probability that the settlement level drawdown will still be achieved. Large drawdowns can occur quite suddenly and quickly, in such cases, the VaR-method does not work.
Another way to estimate the volatility index is Lake Ratio. Lake - Lake, translated to English now understand why this name. Imagine a graph tool necessary to us (action trading account portfolio performance) showing peaks profitability and drawdown. Now imagine the rain, walking in the mountains or hilly terrain, where each depression filled with water. Pofantaziruet and "drag" it to the chart, admire, as water fills each drawdown (figure below). The total water area characterizes the magnitude and duration of the drawdowns.
risk assessment with the help of LR
If we divide the total water area in the area of land for a certain period of time, we get a figure Lake Ratio. The amount of profit divided by the Lake Ratio, gives another measure of volatility - the normal yield. Bank accounts and other tools, which can be earned without subsidence, it is not necessary to evaluate this method.
Stress testing (testing on historical data)
Stress testing is a test trading strategies and risk management techniques on past data, this test leads to an understanding of the profitability and the depth of subsidence. The problems of this approach appear to traders who sell intuitively, so their trading system will not translate into computer code and test. The other stress testing provides the following advantages: (1) a clear way to determine the size of the position, (2) high credibility of the trading methods, tested on historical data, (3) the ability to experiment with setting the risk / return profile, thus changing the amount of drawdown and profit potential .
portfolio selection
Not everyone shares the same move. Some grow hundreds of times, others fall to 1% of the value of the peak values. The portfolio of the most effective tools to surpass the portfolio from less profitable. This should be considered in the stress test, the selection of tools is a critical impact on the results.
Number of tools in the portfolio also affects the performance. A small number of tools leads to greater volatility, sometimes in a higher yield of the tests; The more tools included in the portfolio, the more stable it will be growth.
position Sizing
When calculating the size of the position can come from existing capital, or risk. Consider the following example, the trader intends to sell 20 shares, capital of $ 1 million, while the drawdown should not exceed 10% of the bill.
We calculate the size of the position, based on our capital, divide it into 20 separate accounts, 50 000 $ for each share. Since the per share prices are different, will be different and the number of units that can be purchased at the same amount, ie, the position size for each stock is different.
Stress testing (testing on historical data)
Stress testing is a test trading strategies and risk management techniques on past data, this test leads to an understanding of the profitability and the depth of subsidence. The problems of this approach appear to traders who sell intuitively, so their trading system will not translate into computer code and test. The other stress testing provides the following advantages: (1) a clear way to determine the size of the position, (2) high credibility of the trading methods, tested on historical data, (3) the ability to experiment with setting the risk / return profile, thus changing the amount of drawdown and profit potential .
portfolio selection
Not everyone shares the same move. Some grow hundreds of times, others fall to 1% of the value of the peak values. The portfolio of the most effective tools to surpass the portfolio from less profitable. This should be considered in the stress test, the selection of tools is a critical impact on the results.
Number of tools in the portfolio also affects the performance. A small number of tools leads to greater volatility, sometimes in a higher yield of the tests; The more tools included in the portfolio, the more stable it will be growth.
position Sizing
When calculating the size of the position can come from existing capital, or risk. Consider the following example, the trader intends to sell 20 shares, capital of $ 1 million, while the drawdown should not exceed 10% of the bill.
We calculate the size of the position, based on our capital, divide it into 20 separate accounts, 50 000 $ for each share. Since the per share prices are different, will be different and the number of units that can be purchased at the same amount, ie, the position size for each stock is different.
Dividing the capital of 50 000 $ to 50 $ price for 1 piece, we get the maximum number of shares.
Now we calculate the position size based on risk. For the risk we take the distance between the opening price and the stop loss level. Since we divided the total capital to 20 separate accounts, the risk for each of them shall not exceed 10% or 5 000 $. Dividing the risk capital, ie $ 5000 risk per 1 share, obtain the position size (number of shares).
Now we calculate the position size based on risk. For the risk we take the distance between the opening price and the stop loss level. Since we divided the total capital to 20 separate accounts, the risk for each of them shall not exceed 10% or 5 000 $. Dividing the risk capital, ie $ 5000 risk per 1 share, obtain the position size (number of shares).
Dividing the risk capital 5 000 $ a risk for 1 share $ 5, we obtain the position size - 1,000 shares.
For very tight stop and a high risk capital, all funds in the account may not be enough to open a position desired volume (see action C).
Psychological nuances
In practice, the most important psychological factor is the ability to follow the system. To achieve this, you need to (1) fully understand the strategy rules, (2) to know how the system behaves.
As we noted earlier, the gains and losses alternate with each other, there are whole series. When there is understanding of all possible situations, even the most unexpected, while the drawdown is transferred more easily manage and not to succumb to euphoria at a good profit.
Risk management - results
For the competent risk management:
1. Check the trading strategy and risk management approach to automation;
2. Consider diversification and portfolio choice in testing tools;
3. Choose the optimal parameters on the basis of tests carried out;
4. A clear understanding of the potential volatility and potential profitability;
5. Maintaining a relationship of trust between investors and managers;
6. The most important thing - to follow the strategy;
7. See item 6.
This all comes to an end this article, and with it a whole lot about risk management.
For very tight stop and a high risk capital, all funds in the account may not be enough to open a position desired volume (see action C).
Psychological nuances
In practice, the most important psychological factor is the ability to follow the system. To achieve this, you need to (1) fully understand the strategy rules, (2) to know how the system behaves.
As we noted earlier, the gains and losses alternate with each other, there are whole series. When there is understanding of all possible situations, even the most unexpected, while the drawdown is transferred more easily manage and not to succumb to euphoria at a good profit.
Risk management - results
For the competent risk management:
1. Check the trading strategy and risk management approach to automation;
2. Consider diversification and portfolio choice in testing tools;
3. Choose the optimal parameters on the basis of tests carried out;
4. A clear understanding of the potential volatility and potential profitability;
5. Maintaining a relationship of trust between investors and managers;
6. The most important thing - to follow the strategy;
7. See item 6.
This all comes to an end this article, and with it a whole lot about risk management.
