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Risk Management Notes

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by Fernando Gonzalez -  Feb 8, 2007
5.3 (from 9 ratings)

It is surprising that most traders do not recognize the idea of Buffer Building. In the figure above, the inner black circle represents our trading capital. Our job as traders is to initially build a small buffer around that capital, perhaps only a few % of the account value. This is represented by the dotted gray line, and will serve as the trader's primary goal – to build the Buffer around the account with limited exposure. Once the buffer is achieved, then and only then can he "increase" the volume dial to a higher rate of exposure. He then will set a NEW Buffer zone to build around his capital in order to protect him from future increases in risk exposure, but only increasing exposure once the buffer is built. This process continues perpetually for the trader's life time.

A trader who is correctly managing his risks therefore exists only in one of two primary states: BUFFER BUILDING and CAPITAL PRESERVATION. If he is not building Buffers, he is protecting capital. The state of CAPITAL PRESERVATION is the process of trading at absolute minimum risk exposure until the Buffer is regained.

This method provides the trader a specific focus on exactly what he needs to do, and setting goals that are well-defined, achievable and incremental in nature. Having the correct focus makes "discipline" easier to carry-out. Build your buffers and modulate your risk: this is the simple process and path you need to take to grow your account. Stop-losses are a critical part of this process, but it is merely a piece of a larger, more important process.

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Comment on this Article

Recent Comments:
I can only assume (as it is not made clear) is that what the author means by "building a buffer" is that in order to increase any risk one first needs to increase the amount of capital, presumably by sensible trading, before increasing the amount of risk being carried. Can there be any other kind of buffer? I assume that R is a dynamic amount, based on your account size (assuming only 1 trading account without reserves elsewhere) and not some constant based on your initial capital. This...
_coda   19-08-2007 07:56:05
Fluff. Maybe title should be "If you have never dealt with Rish Management before"
rcanfiel   29-06-2007 14:09:15
Imho, the main problem concerning risk management for many (not only new!) traders is, that they aren' t able to calculate a sufficient account size in dependence of their selected trading concepts or systems. Risk is even under-estimated under known current market conditions, but specially under possibly changed market conditions in future. There are methods out (not to solve all problems, but) to help in this context (monte carlo simulation, data scrambing etc.), but there's some...
zentrader22   11-03-2007 04:23:32
the author is taken his thesis for real. He didn't prove his thesis. No examples were given. "A good thesis statement makes the difference between a thoughtful research project and a simple retelling of facts" The game of investments goes far deeper. Andree Kostolany thesis goes far deeper and has been proved : There is undeniable proof that a long term investment runs into profit. "The proof of the pudding is in the eating" P.S. : # SIZE: The more we expose our account, the...
pssonice   08-02-2007 05:42:46

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