Risk Management

What is risk management?

I discovered there are many types of risk management.

Financial risk management

is the practice of creating economic value in a firm by using financial instruments to manage exposure to risk, particularly credit risk and market risk. Other types include Foreign exchange, Shape, Volatility, Sector, Liquidity, Inflation risks, etc. Similar to general risk management, financial risk management requires identifying its sources, measuring it, and plans to address them.

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Financial risk management can be qualitative and quantitative. As a specialization of risk management, financial risk management focuses on when and how to hedge using financial instruments to manage costly exposures to risk.

(source: http://en.wikipedia.org/wiki/Financial_risk_management)

Identify It’s Sources

• proven system with positive expectancy• greeks– delta - price– gamma - price and time– theta - time– vega - volatility, beta– rho - interest rates

• liquidity

Identify It’s Sources

• product (read the prospectus, LLC income tax K-1 form for UNG)– ETF– ETN – TVIX(read http://www.vantharp.com/Tharps-Thoughts/572_Apr_11_2012.html)

–NAV (Net Asset Value) (-IV .IV)

Identify It’s Sources

• events– earnings– news– company or broker mis-management (MF Global)

• leverage• margin

Measure It

• TOS analyze tab, trade tab• SEC reports 10-K, 10-Q• analyst reports• news stories• your trading records

Manage Exposure to Risk

• money management– position sizing– use stops - "your first loss is your best loss" -

Rozycki– hedge with options or futures– capital allocation• business• accounts• systems• trades

Manage Exposure to Risk

• portfolio management• diversification– class - stock, option, future, forex– sector– market cap– beta

Manage Exposure to Risk

• directional risk (have both long and short positions, or bonds and stocks)

• loss limits– daily, weekly, monthly (Merlin Rothfeld $250 per

trade $500 per day limits)– Alex Elder 2% per trade 6% per month

Manage Exposure to Risk

• trade execution errors– continually learn and become proficient on your

trading platform– know how to contact your broker and what

information they will need• trade management– from order fill to close of trade

Manage Exposure to Risk

• personal psychology– health– mood– relationships– stress– environment– recent large loss or win

Manage Exposure to Risk

• equipment– computer– back-up computer– internet– back-up internet– list of positions on paper in case of power outage

Plans to Address Risk

• business plan• trading plan• trade log • trade journal• risk management plan• trade management plan

Plans to Address Risk

• personal management plan• review plans- daily, weekly, monthly• "plan for every conceivable contingency" - Joe

Ross• you are responsible for everything, so plan for

everything

Why Use Stops?

• prevent a large loss• protect a profit• enter a position

Types of Stops

• stop market– prevent loss– enter a position

• stop limit– enter a position

Types of Stops

• time stop– prevent loss (option expiration)– maximize capital (opportunity cost)– enter a position at best time of day

• trailing stop– protect profit

Where and how to determine the best price level for stop placement?

• at a price where your original trade idea is no longer valid

• beyond demand (support) or supply (resistance) zones

• beyond highs or lows

Where and how to determine the best price level for stop placement?

• at specific profit points (75% rule – Vadym Graifer)

• a percentage of the ATR - volatility stop• away from round numbers or specific indicator

levels

Are stops always necessary?

• No– a defined risk option trade– a properly hedged position

How do you determine where to place stops?

Questions?

The End