Prudent Risk Management Is The Only True Edge In TRADING
- Thread starter Buy1Sell2
- Start date
Just to share my input on this topic.
IMO prudent risk mangament is essential to any good trader. But it by itself is not an edge. Risk management will definitely help prevent too huge a drawdown or to reduce the volatility of your portfolio. But it will not deliver positive expected return. For that, you would need to rely on your trading/investing strategy!
IMO prudent risk mangament is essential to any good trader. But it by itself is not an edge. Risk management will definitely help prevent too huge a drawdown or to reduce the volatility of your portfolio. But it will not deliver positive expected return. For that, you would need to rely on your trading/investing strategy!
What is the reason that most traders lose or blow up their accounts?
I can only speak for retail traders. Based on my acnecdotal accounts, there are a few factors:
- Overleverage. Betting the farm on every trade with high leverage. This is rather prominent in short-term orientated traders. A few big losses would wipe out their accounts.
- Overtrading. The constant need to be trading even without a solid rationale. You are more prone to taking emotional trades this way. Not to mention the trading costs that racks up.
- Revenge Trading. Wuuu this is a killer!
- Holding on to losers until it hurts. This is subjective to your trading strategy. Some traders prefer to cut their losers fast, while other prefer to ride out the drawdown as their conviction in the trade is still strong. But the idea is not to hold on to a losing trade because of "hope". If your conviction is still strong, then by all means hold on to it. But if you are holding on to a losing position "waiting to get out at a better price", then it may be a big mistake.
- Underestimating volatility. This adds on the the previous point about drawdown riders. The typical mistake is underestimating how much volatility an asset will go through. Because you did not check the historical volatility or perform your Var analysis. Thus you end up trading too big and/or setting too tight a stop loss.
- No due dilligence For the quants, it could be you did not backtest and/or stress test your strategy/algorithm. For those such as value investors, it could be that you did not check every filing/report of the company you are analysing. There could be some "dirt" which you may have missed.
I guess a quick summary is that the abovementioned are all rather easily avoidable mistakes which has nothing to do with your ability to trade. But as humans we do make these mistakes now and again. More so for retail traders. Probably due to lack of experience? Or maybe greed?
These are all items that fall outside of Prudent Risk Management. In other words, a trader that does not engage in these is going a long way towards sticking with PRM. --Every one of your points is related to poor risk management. PRM is the only true edge in trading.
I would like to repeat myself. PRM is NOT an edge. A trader that has PRM will survive longer than one whom dont. But it will not deliver a positive expected return.
With a negative expectancy, even the most prudent of risk management will still bankrupt you eventually.
PRM creates positive expectancy.
Try using PRM in a casino and tell me you can "create positive expectancy"
Casino games have no similarity to trading.