Why only 1% Capital Risk when trading

[Gardan]

Catastrophe event planning, e.g. terrorist attack, needs to be considered and there are easy "insurance" choices such as long deep OTM puts.

Richard, if you have time could you explain what an OTM puts is and how it may be used as insurance. Is it to do with purchasing Options?

Thanks Gary

 

[Mr. Charts]

Gardan,
I used to trade options but find trading US stocks intraday a great deal more profitable so it seems appropriate I should leave that to our resident options expert, RogerM. Much that is written on BBs is not accurate and is misleading, but I have total confidence that what he would say will be completely accurate.
Richard

 

[Salty Gibbon]

Maybe a thread on Disaster Planning would be a good idea.

I'm sure it would make interesting reading.

I am equally sure that most people do not adequately address the issue of a catastrophic market collapse and the potential effect on their trading account.

 

[Gardan]

Salty,

It is total "Account Exposure" that I am concerned with so that if a stock dropped to 0 then I am still able to walk away owing nothing. Personally I dont risk more than 0.4 of 1% of my account on any trade.
Paul

Paul, you would need $400k/500k + cash , to trade this sort of scenario, would you not?
Dealers fees/spreads ect, would soon wipe out any thing less wouldn't they?
Or be limited to trading small value stocks?

Traders with less amount of funds therefore need to take more risks, is this correct?

Gary

 

[Salty Gibbon]

I personally follow the same approach as Paul and rarely have an open market exposure greater than my cash balance.

My risk per trade also rarely exceeds 0.3 to 0.4% of my cash balance.

This leads me to ask the question, what is the point of having a margin account where I can trade up to 4 times my cash balance, if I never use the facility.

Am I being overly prudent in providing for a disaster that has about as much chance of happening as West Brom winning the Premiership, or does anybody think that West Brom could one day do just that ?

 

[Gardan]

I
Am I being overly prudent in providing for a disaster that has about as much chance of happening as West Brom winning the Premiership, or does anybody think that West Brom could one day do just that ?

If Paul & Tony pool there dosh and buy West Brom. I think they could make Chelsea look like a conference league team.

So Yes, Black Swans are available to the "Beautiful Game" too.

 

[Gardan]

Re: T2W Members awards 2004. Well done TheBramble. I must say I agree with one of them (which I voted for you, case of wine prize, wink,wink,nudge nudge) but they other one.......nahh!

Really Tony, top draw and well deserved.

 

[TheBramble]

So if you had a US$ 50,000 pot and you decided to trade Google, you would only trade 25 shares based on your rules.

The math is right Salty, as is the principle.

...but the prerequisites and assumptions not.

I (typically) only trade stocks in the $20-$60 range (with rare, very rare exceptions at both ends of the range). But if I did trade a high-price (relative) stock with my rules - they would apply, rigidly. Bearing in mind the R:R - even if in line with my goals would need to be worthwhile 'overall'. No point trading a great 1:10 R:R if it's only 25 shares....

 

[TheBramble]

The concept that you should trade say, 451 shares of a $22 stock or 296 shares of a $33.52 stock because you think your maximum calculated exposure size should be $9922 is not the approach of a careful risk averse trader, (as I am).
It is the sign of a bean counter mentality which will lead to profits barely amounting to a string of beans.
Richard

So Richard, how do you calculate your risk (of much less than 1%) for each trade and the size of the position to take?

 

[TheBramble]

This leads me to ask the question, what is the point of having a margin account where I can trade up to 4 times my cash balance, if I never use the facility.

It's like having a credit card, but one where (conceivably) one day they can come and ask you to settle it all - there and then - and possibly up to 4X the amount you've 'spent'.

From 'their' point of view it's great business. Traders will trade far greater size (===> more commissions) than they would without.

Use of margin is great as long as you always get it right and there are no unforeseen events that wipe you out....

 

[Trader333]

Garden and Salty,

I think there may have been some misunderstanding here. Market exposure is not the same as "intended" risk per trade. In my view it is unwise to have a market exposure greater than an account balance just in case a one off event occurs. It is the same view as saying "Well I am a good driver therefore what need have I of car insurance" and then one day someone smashes into you and writes your car off. All that really matters is not exposing yourself to the potential of financial disaster and should the unthinkable happen to me when in a trade then I may well lose $50K but I am able to walk away owing no-one anything and that is the bottom line for me.

The amount risked per trade is not the same as market exposure. So the maximum I am prepared to lose before I would close a trade is 0.4 of 1% of my account. That is the maximum and in most cases I am out before that is hit as there are ways of knowing that the trade is not likely to make a profit before that would happen.

I have found that there are people who have a natural intuition for trading and therefore do not need to have set limits for loss or profit taking. However, intuition cannot be taught and takes time to develop and most people dont have it sufficiently developed or we would have a much higher percenatge of profitable traders than we do. For those who have not yet developed an intuitive approach to trading then a rule based method makes sense as it is easy to follow and it is easy to measure the level of discipline attained by the developing trader against the rules, ie did they close the trade at a set loss or did they lack the discipline to do so etc.

Incidently this approach works well as it is based on statistical norms, (which are dismissed by many), that have proven themselves over a long time and as data is being added on an ongoing basis then there is no reason to believe that it will not continue to work into the future.


Paul

 

[TheBramble]

So why not just put $900k in the bank and gung ho it (so to speak) with the $100k ,risk is the same is it not?

It's because I'm trading less than 1% Risk and less than 10% Exposure that I do trade the way I do. Comfortably, without stress, fear or tension. Just neutral. If the trade goes against me no problem - small loss. If the market dies - eyes widen, pulse quickens - but hey, I'm still up for the next open. It wouldn't be the same if I was all in but only utilising 10% of total. Quite a different dynamic.

Graydin, as I keep saying - it's a very personal thing in that each trader is potentially going to want different things from their trading and their setup and risk and money management will reflect that.

I started out a LOT more aggressive and over-committed - yessir....!!!

Also what if I had 1/2 of my open positions on Buy and half my open positions on sells, would you factor this in to your risk. Or should I also consider that if I had say 5 or 6 open positions (which is well beyond my capabilities but I live in hope) that 5 or six Black Swans may come down simultaneously and land on all my positions.

If one of the Swans lands on my Sell trades would I be quids in?

Not sure what you mean.

I suppose this would be the ultimate in pair trading. You should market it. Black Swan Pairs (tm).

 

[Salty Gibbon]

I think there may have been some misunderstanding here.

No misunderstanding at all Paul.

I am quite clear about the difference between risk per trade and total open market exposure.

I am glad that this topic is being aired because, although subconsciously I do not allow myself to trade an exposure beyond my cash balance, I have not actively considered disaster planning before.

In the same way I only use credit cards very rarely but this is not a conscious decision I have made. It's just instinctive not to use them.

It is interesting to hear the differing views and the different levels of prudence and conservatism being adopted.

I am sure there are oodles of people out there trading an open exposure right up to 4 times their balance, then there are the safety conscious people who will not trade beyond their cash balance and then we have people like Bramble who will only trade with an open market exposure of 10% of his cash balance.

It is also interesting to observe that people with large pots are often the most conservative.

Conventional thinking might lead one to come to the opposite conclusion.

 

[Gardan]

It's because

Not sure what you mean.

I suppose this would be the ultimate in pair trading. You should market it. Black Swan Pairs (tm).

Also what if I had 1/2 of my open positions on Buy and half my open positions on sells, would you factor this in to your risk. Or should I also consider that if I had say 5 or 6 open positions (which is well beyond my capabilities but I live in hope) that 5 or six Black Swans may come down simultaneously and land on all my positions.

If one of the Swans lands on my Sell trades would I be quids in?

Hi Tony, Re above, What I mean, is from a disaster planning point of view like, 911-West Brom winning the Premiership or L'pool getting beaten today my them nice chaps from Manchester.
For the record 3-1 to the pool Or Man U might get a lucky win 1-0 with 10 men.

If the market was to fall 20/25% in a day or more. If I had two sell trades and two buy trades in the market when this happened. I could possibly expect a Nil, Nil Draw. Could I not.

Of course this would not apply to them nasty birds as they are more particular as to where they may land.

Garingo

 

[Salty Gibbon]

Better to quit your buy trades at the first sniff of serious trouble and ride your shorts down.

Your 0-0 draw might then become a 4-2 win, or even 5-1 if you quit your longs early enough.

By the way I reckon Liverpool have as much chance of winning the Premiership as there is of a flock of black swans flying down Wall Street on Tuesday morning.

 

[Gardan]

It is also interesting to observe that people with large pots are often the most conservative.

Conventional thinking might lead one to come to the opposite conclusion.

Salty, good point. It would be interesting to know if the large pots that some people may have came from a similar strategy or from a more aggressive risk strategy. Or from some other source.

What I am slightly confused about is, if a trader with $100k adopted this strategy the would be mauled to death by commissions and fees, would they not.

Bramble, you mentioned you have lost your shirt (and obviously bounced back-respect) whilst doing your 8/10 years apprenticeship. Was any of these losses due to the unusual events we have discussed. Or more to do with an aggressive trading strategy.

Gary

 

[Gardan]

Better to quit your buy trades at the first sniff of serious trouble and ride your shorts down.

Your 0-0 draw might then become a 4-2 win, or even 5-1 if you quit your longs early enough.

By the way I reckon Liverpool have as much chance of winning the Premiership as there is of a flock of black swans flying down Wall Street on Tuesday morning.

Salty, Sadly I agree on BOTH your points

 

[Salty Gibbon]

Never mind Gary. The same also applies to Everton.

 

[Trader333]

Garden,

You are touching on the subject of pair trading which is used to offset market movements either up or down and is an interesting subject in its on right. However, this does not cater for the unexpected suspension of a stock from trading although it can be used as a means to offset sudden movements in an index such as the Dow.


Paul

 

[Mr. Charts]

Gary,
Just to clarify my post 42 if I have not made myself clear - IMHO the best person to ask about options is Roger M.
I regard him as being not only a better options player than I am but know that anything he says will be spot on and well expressed and imho will be of maximum benefit to readers.
Since I do not actively trade options I simply do not think it is appropriate for me to expound on the subject, so I won't.
Richard