Vol 1: Risk management and more

...continued from yesterday...

"How to Use Risk" is the title of Volume One of the Peak Performance Course for Traders and Investors .

Before getting to the point, namely how to use risk, Van discusses other topics.

1. Commitment. Although Van is a psychologist, he is not talking about getting committed to a mental hospital. Rather, he makes the point that commitment means congruency in wanting to succeed in making money as an investor or trader. He points out that both the desire for profits as well as the aversion to losing are obstacles to commitment.

2. Tasks of Trading Success. These include writing out a plan for trading that is low risk and that suits your personality, lifestyle and skills; mentally rehearsing that plan daily or more frequently; getting into a mental state suitable for trading successfully and monitoring your mental state; stalking a low risk trading idea; entering the trade; monitoring the trade; exiting the trade with profits or with a loss; daily reviewing whether you followed your plan and reinforcing your discipline in following your plan; periodically (e.g. every 20 trades) examining your profits/losses to decide if your plan needs to be fixed; and taking vacations away from trading.

3. The loss trap. Reasons people let a small losing trade grow into a big loser that wipes out most or all of their account.

On the matter of risk, Van’s course teaches the following.

1. How to measure risk objectively. Risk has two definitions. The objective definition is the variability in performance of invested funds. The subjective definition is the probability of losing. Some ways to measure risk objectively include the standard deviation of profits/losses; the probability of success; calibrating your ability to predict; and preparing an accounting Statement of Revenues and Expenses.

2. Psychological elements of risking. Lots of theory here. Read the book if you want.

3. Techniques to control risk and safely manage money. These include using a stop loss order on each of your trades and pyramiding during a winning trade. Van points out that if you cannot accurately predict which trade will turn out to be a winner, then you should start a trade by risking only 1% or loss of your account on the first position. If that position is a loser, take your 1% loss and get out. But if the trade continues to be profitable, add more to it by pyramiding. The ways to pyramid include adding half the size of the prior position each time; adding half of the total current position each time; adding equal sized portions each time (the type of pyramiding you use depends on your low risk trading plan). Additional means of reducing risk include diversifying (over time, asset traded, and system traded); reducing leverage; taking only low risk trades and no others; taking profits either consistently or in large size only; and controlling yourself (managing stress, internal conflict, beliefs, emotions, mental strategies, and judgmental biases).

...cont'd tomorrow...

Copyright 2007 Raymond T. Lee. All rights reserved.
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