RISK and how we deal with it.

deaddog

deaddog

In another thread

Redneck said:
I've never seen a healthy dialogue regarding risk on this forum - we.., who are not shy about it - should have one

RN
More...
And I agree.

What is Risk and how do we as traders cope with it. Let’s start by defining risk.

Dictionary Definition of risk:
1: possibility of loss or injury : peril

2: someone or something that creates or suggests a hazard

3a: the chance of loss or the perils to the subject matter of an insurance contract; also: the degree of probability of such loss
b: a person or thing that is a specified hazard to an insurer
c: an insurance hazard from a specified cause or source <war risk>

4: the chance that an investment (as a stock or commodity) will lose value.

Deaddog definition of risk;
1: The probability that things will get worse if I do nothing.


The markets operate on Fear and Greed. In order to overcome Fear we must take a Risk.

The obvious Risk we face as traders is that the price will move against us as soon as we enter a trade. (Fear of a loss)

Then we face the Risk that the trade will work to perfection the minute we close our position. (Fear of missing a move)

There is also the Risk of the trade not going according to plan, (Fear of being wrong)

I'm sure there are many other Fears.

Ask most traders why they were doing something and the answer usually starts with “I was afraid that”. Which fear is affecting your trading?

What RISKs are you taking. and more important what can you do to mitigate or control those risks.
 
deaddog said:
What RISKs are you taking. and more important what can you do to mitigate or control those risks.
More...

This may be helpful. Before assessing and assuming risk, one must first understand exactly what it is he's about to engage:

I am sick of hearing people say that 90% of traders lose because the market chews them up or the system doesn't work or whatever. That is just BS. The problem is those traders spend all their time playing with indicator values or analyzing timeframes or whatever and they miss the whole point of what they are doing here. This is a MARKET.

All markets have buyers and sellers. I don't know why everyone can be experts on value when they look at items in a store or a piece of real estate or whatever but not in the market. If you wanted to sell your house for 500k and you had nobody even look at it in a booming market what would that tell you? The price was too high. Would you then raise the price of the house the next day? Of course not, you drop your offer if you wanted to sell it. You see what I mean? Markets make sense when we are talking about real estate or whatever, but people just blindly look at indicators and follow systems even in the face of obvious current price information.

Example: in the last 5 minutes price has had a high failure at 1350 three times and is currently trading at 1348. Do you take a long setup here because a momentum indicator is above zero and the 9 day moving average just crossed over and above the 20 day? Why not, don't we always have to stick to our trading plan blah, blah, blah? That is a great example of how traders follow systems to the letter and then scratch their heads because they can't figure out why they are losing. Into the 90% pile they go. This isn't a ridiculous example either. This scenario repeats itself about once every 10 minutes on most days in any market.

Anon

​

IOW, if one doesn't at least understand the nature of what it is he's about to become involved in, then he is far more likely to be fearful, just as our ancestors were afraid of fire, or of sailing off the edge of the world.
 
Perhaps try this:

TAIL RISK HEDGING: Creating Robust Portfolios for Volatile Markets [Hardcover]
by Vineer Bhansali

"
"TAIL RISKS" originate from the failure of mean reversion and the idealized bell curve of asset returns, which assumes that highly probable outcomes occur near the center of the curve and that unlikely occurrences, good and bad, happen rarely, if at all, at either "tail" of the curve. Ever since the global financial crisis, protecting investments against these severe tail events has become a priority for investors and money managers, but it is something Vineer Bhansali and his team at PIMCO have been doing for over a decade. In one of the first comprehensive and rigorous books ever written on tail risk hedging, he lays out a systematic approach to protecting portfolios from, and potentially benefiting from, rare yet severe market outcomes.

Tail Risk Hedging is built on the author's practical experience applying macroeconomic forecasting and quantitative modeling techniques across asset markets. Using empirical data and charts, he explains the consequences of diversification failure in tail events and how to manage portfolios when this happens. He provides an easy-to-use, yet rigorous framework for protecting investment portfolios against tail risk and using tail hedging to play offense. Tail Risk Hedging explores how to:

Generate profits from volatility and illiquidity during tail-risk events in equity and credit markets
Buy attractively priced tail hedges that add value to a portfolio and quantify basis risk
Interpret the psychology of investors in option pricing and portfolio construction
Customize explicit hedges for retirement investments
Hedge risk factors such as duration risk and inflation risk

Managing tail risk is today's most significant development in risk management, and this thorough guide helps you access every aspect of it. With the time-tested and mathematically rigorous strategies described here, including pieces of computer code, you get access to insights to help mitigate portfolio losses in significant downturns, create explosive liquidity while unhedged participants are forced to sell, and create more aggressive yet tail-risk-focused portfolios. The book also gives you a unique, higher level view of how tail risk is related to investing in alternatives, and of derivatives such as zerocost collars and variance swaps. Volatility and tail risks are here to stay, and so should your clients' wealth when you use Tail Risk Hedging for managing portfolios.
"
 
deaddog said:
In another thread


And I agree.

What is Risk and how do we as traders cope with it. Let’s start by defining risk.

Dictionary Definition of risk:
1: possibility of loss or injury : peril

2: someone or something that creates or suggests a hazard

3a: the chance of loss or the perils to the subject matter of an insurance contract; also: the degree of probability of such loss
b: a person or thing that is a specified hazard to an insurer
c: an insurance hazard from a specified cause or source <war risk>

4: the chance that an investment (as a stock or commodity) will lose value.

Deaddog definition of risk;
1: The probability that things will get worse if I do nothing.


The markets operate on Fear and Greed. In order to overcome Fear we must take a Risk.

The obvious Risk we face as traders is that the price will move against us as soon as we enter a trade. (Fear of a loss)

Then we face the Risk that the trade will work to perfection the minute we close our position. (Fear of missing a move)

There is also the Risk of the trade not going according to plan, (Fear of being wrong)

I'm sure there are many other Fears.

Ask most traders why they were doing something and the answer usually starts with “I was afraid that”. Which fear is affecting your trading?

What RISKs are you taking. and more important what can you do to mitigate or control those risks.
More...
One major problem with dealing with risk (and it must be dealt with; no point in pretending it isn't important) is that we not only don't have a good universal way of measuring it, we have a very bad nigh-universal way of measuring it. Back in the Fifties, a lazy economist named Harry Markowitz looking to finish his PhD thesis decided to take a shortcut (naturally, because that's what lazy people do) and so he used the well-established measure of uncertainty known as standard deviation (sdev) as his measure of risk. IOW he looked at two things most people dislike instinctively -- uncertainty and risk -- and treated them as if they were one and the same. Of course they aren't one and the same. Uncertainty works in your favor half the time, statistically speaking. Risk by definition (before the Markowitzians fucked up the definition) never works in your favor.

So before we go much further, perhaps we should agree to seek a common measure of risk that makes sense for traders.
 
Risk is a tricky one.

There are some that come from the school, that your stops should be small, as you can always re-enter. Even some that counter this by saying death from a thousand stops is not much different from large stops although you could limit number of entries per area to avoid this.

Others prefer to use stops outside of noise, others counter this by saying this prevent you from exploiting leverage efficiently.

I think you define risk by doing a combination and comparison of your setup performance, past live performance tests with small size and the expectancy of your setups based on thorough backtest.

All in all, protect capital at all cost, worry about risk first, then reward.

Respect the ability to be able to trade another day.

Trading profitably is a marathon, not a sprint, adjust risk accordingly.
 
deaddog said:
What RISKs are you taking. and more important what can you do to mitigate or control those risks.
More...

For me this is not even a question, because the amount of risk you are taking on each trade must only be dictated by your own fully backtested trading system.

You cannot simply place and trade and say "Ok, let's see here, how much risk am I willing to take...?".

The minute you do that you are bullshit trading, because your stop and the OPTIMAL percentage of trading capital to allocate to each trade must be clearly predetermined in advance, via intensive backtesting and research, end of story.
 
kut2k2 said:
... perhaps we should agree to seek a common measure of risk that makes sense for traders.
More...
But before we can agree on a common measure of risk, perhaps we should agree on a common definition of risk. Which will be a challenge.

For example, from Wikipedia: "Without uncertainty, there is no risk, only clear danger." I'm not at all sure I buy this spurious distinction between risk and danger. The insistence of associating uncertainty with risk has Markowitzian hand prints all over it.
 
my 2 standard deviations worth....

risk has to be associated with uncertainty.....as risk is about potential loss.

example: at present it is certain that we are going to die. But it is uncertain how or when or why.
So when talking about the risk of death you have to apply uncertainty.

This is then separate from how to measure risk and how to judge it and how to compare risks v other risks and v returns.

Simply because you can have situations whereby you can have zero risk but no reward, small risk and huge rewards, small risk v large risk for the same reward or different rewards, risks can be offset against each other,etc;

Hence for me - -- Risk is the potential of losing something of value

An event can cause both loss and gain at the same time. eg; there is a risk of divorce when you are married, but this event might bring other opportunities, and the value of the marriage might have decreased so much its worth it.

After this, then ideas of measurement and comparison come into play, but I think uncertainty (via the word potential) is essential.
 
SIUYA said:
my 2 standard deviations worth....

risk has to be associated with uncertainty.....as risk is about potential loss.

example: at present it is certain that we are going to die. But it is uncertain how or when or why.
So when talking about the risk of death you have to apply uncertainty.

This is then separate from how to measure risk and how to judge it and how to compare risks v other risks and v returns.

Simply because you can have situations whereby you can have zero risk but no reward, small risk and huge rewards, small risk v large risk for the same reward or different rewards, risks can be offset against each other,etc;

Hence for me - -- Risk is the potential of losing something of value

An event can cause both loss and gain at the same time. eg; there is a risk of divorce when you are married, but this event might bring other opportunities, and the value of the marriage might have decreased so much its worth it.

After this, then ideas of measurement and comparison come into play, but I think uncertainty (via the word potential) is essential.
More...
So there is no risk associated with drinking Jim-Jones koolaid because there is no uncertainty (e.g., 100% fatality) associated with drinking Jim-Jones koolaid?

Sorry but that is too weird. Potential means 'might happen in the future' but that doesn't mean the outcome is uncertain. If you live long enough, you will die eventually. The event of you somehow gaining immortality is infinitesmally small (i.e., sufficiently close to zero to be utterly negligible). Fact: someday you will die. There is no uncertainty about the outcome. Does this mean life is risk-free? Of course not. Fact: if you drink Jim-Jones koolaid, that is the day you will die. There is no uncertainty. Does that mean drinking Jim-Jones koolaid has no risk? Ridiculous!!

I believe the concept of risk is big enough to encompass outcomes that are both certain and uncertain. Potential for loss need not be uncertain. It need only be preventable by a different course of action. The uncertainty is whether you choose to perform an act that is certain to kill you, not whether performing the act will kill you. And if you're not suicidal and not stupid enough to put your future in the hands of Jim Jones where he has every opportunity to kill you because he is a homicidal maniac, then the risk that you die from association with Jim Jones becomes vanishingly small.
 
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