TheRiskBlog

It is not necessary to know the next market move if the portfolio lives by risk management rules

I am sitting here at the bottom of the world famous “Eiger Nordwand” (Eiger North Face) in Switzerland with 5 open positions in my account.

How does that work as far as riskmanagement is concerned?

Well, given, this article is being written on an iPhone and having an iPhone available certainly helps. First of all i can check stockprices online, which is not a problem because they have UMTS available even here directly at the bottom of the Eiger.

But does it help to know the prices? No, because knowing the prices doesn’t change anything in my account. I need to be able to sell positions if the need be.

So, secondly i need to have a way of calling my broker to size down or even completely sell positions in the account. Only then having an iPhone available helps. Did i bring the number of my broker? Yes, i did and so should you. Make sure that you have the telephone number of your broker readily available, when you are on vacation with open positions.

But then again i’ll be hiking a lot today and it is not practicable to check my iPhone every 5 minutes, so i kind of need an extra method of how to cope with the risk of losing money in my account.

Here is what i did. I first checked the volatility (ATR=Average True Range) of every single stock in my account. I then made sure, that not a single volatility is higher then my total open profit in the account. This way stockprices can drop, but as long as they stay within their historical volatility the dropping prices can not hurt me.

Let´s look at an example. Let´s say we own 200 AAPL and AAPL shows a historical 14 day ATR of $4. That means that we can lose $800 in a single day since we own 200 of them and need to multiply our position by the volatility. 200 * $4 gives $800. If we have an open profit of - let´s just say - $2000 nothing would happen, because even if AAPL drops by its full historical volatility of $800 we still would have $2000 (open profit) - $800 (historical volatility and actual drop today) = $1200, so we´d still be in the green.
But if we only had $1000 of open profit, the drop of $800 would be too much for our account, since this would mean to give up 80% of our open profit, so it would be too much risk for the account. In this case i had to sell 100 AAPL before i went on vacation, just to get the risk level right.

Ok, enough written on the subject, i am on vacation and sitting here at around 5000 feet not moving i am getting cold, so i need to get up and going.

Most trading systems concentrate on the entry system when they should concentrate on the exits. The problem with entrys is, that when opening a trade, it will always be in the red, since it loses the commission to the broker.
Especially when accounts are small, these costs can add up quickly because percentagewise they are expensive.

But finally it is possible to cut costs at entry level. The first broker to give you free trades is Zecco.

Obviously there is a catch. You need to maintain at least a minimum of $25.000 in the account to get those free trades. Nevertheless, compared to other brokers this is a good offer, because according to the Pattern Day Trader rules, anyone who engages in short term trading in the US does need to maintain those $25.000 minimum.

If you want to get the scoop of these rules, you will find a nice explanation here.

Just in case you are looking for the official rule, you can find it at FINRA.

FINRA came into existance in 2007, when the NASD merged its regulatory functions with the enforcement arm of the New York Stock Exchange. It is the abbreviation for Financial Industry Regulatory Authority (FINRA).

It is always good to research before you commit you hard earned money to anything, so go on over to Zecco and check out there community first. People are communicating there trades and the community is building fast.

It was about time, that free trading became available.

…then think again. Did it help in the past, did you make any money by reading the usual stuff?
Not that it is a bad thing to dig your way through the daily gossip about companies, CEO´s, earnings, wrongdoings and other good stuff but what really helps is to find real news. Things that will change the price of a stock, no matter what.

For somebody not familiar with the street slang and all the fancy words journalists use today, it could be a tough task though to find the right little tidbit of news that could mean the next tenbagger in your portfolio.

So, how do you find the real news? Well, the good thing is, you don´t have to. That is already done by Michelle Leder and her staff at footnoted.
She is doing a very good job of digging through the stuff we all could read but are to lazy to do so. By the way she needs your help, she explains it here

you know what this means. When a house is bought you can change anything but the location. So we need to think about the location before we buy, this means we are thinking about the most important factor beforehand or in other words we take care of the single factor that determines the bigger part of the price of the house before we buy.
Now for the stock market the same is true but the phrase goes more like Exit, Exit, Exit….
Other than the location of our real estate we could always change the exit of our trade after we bought the stock, but then again while trading in the market this is the single most important factor to determine our profit.
Oooops…so you thought it was the Entry that made you rich? Not even close, when entering a trade your broker will be happy because he just earned himself some money, not you did.

So this means we are in the red, right there, right after entering the trade and it all looked so good after analyzing before we decided to jump right in. So what does this mean.

It means that we can analyze all we can, it doesn´t mean anything, when we enter the trade we are randomly taking part in the market and the only way we achieve any kind of profit is by controlling a few parameters that we can control.

Obviously we can not control the price movement after we hit the button but we can control how much we want to win or lose. So, we can control our exit and that is exactly what we need to do. You need to take control of your trading and the best way to do that is by controlling the things you can control not the things you can not control.

Welcome to my Risk Management Tips for Beginners Guide.

Step 1:

This entry starts a short series of tips on how to proper manage the risk in your portfolio. It gives you the basics of the risk management process and guides you through the decisions and strategies you´ll have to consider when investing.

For starters this should be a good first.

When we invest in the markets we basically trade two things - those things being greed and fear. If we can identify either one of them, the process of committing our hard earned money becomes a little easier. But because we do not get a hint all the times at what to do in the markets we have to protect our money first.

1. Protect your capital, make sure that you do not lose to much money on any given trade. If you start doing this it will keep you in the game longer and this way you will not miss out on the opportunities.

2. If you can keep your balance close to zero and don´t go underwater to often, winning trades will bring your capital up on their own.

3. Having an opinion is ok, but you need to know what the market actually does. If you thought, the market needs to go down, but it goes up then you turn around your short positions.

So, watch your trades at all times and don´t let your ego come in the way of stopping out on a losing trade.