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 Introduction

 

It is widely known that approximately 90% of traders lose money, and the 10% who win make most of the money lost by the crowd.

It is also known that when allowance has been factored in for dealing costs, the trader's real chances of winning on any trade are approximately 49%.   So what is the reason for this strange difference?

Its can usually due attributed to lack of discipline, poor risk control, and other similar human emotions such as vanity, arrogance, and  attitudes such as "I am right, its the market that is wrong".

 

The system I have developed is made up of a whole set of logical arguments, that have been tested and optimised, altered, retested, and retested again in a continual process.

The end result, is a highly efficient method of trading stocks, to extract maximum profit potential from the market, while also keeping losses and draw downs as low as possible.

 

I have been developing this system since 1998, and have learned many things, probably the subjects of risk control, hedging, gearing, and optimal position sizing have been the most significant changes and enhancements made over the years.

Indeed even now I am still finding ways to make many improvements and refinements to the program.

Probably the hardest part of designing a trading system, is to convert actual human visual concepts of good conditions to trade, into simple computer code, mostly the first attempts are not an accurate reflection of what was intended, so the whole project has been a recursive process. Now the time has come to let the system talk for me, and let it run automatically. How the system works  

 Roger Medcalf  2005

 

Different types of risks identified

 

 

   Market risk

 

This is defined as being, when the whole world stock indices have a violent move all at the same time, as in 1987, or the 911 disaster. Equally dangerous would be a violent up move when the trader is carrying a large amount of shorts. (But this scenario can be considered quite rare)

 

   Idiosyncratic risk

 

This is defined as being the risk associated with the individual company stock that one owns, for example, if you are long, and the company announces a profit warning, or some large shareholder decides to sell his holding, then you are exposed to idiosyncratic risk.

Number of Punters risk, this is defined as a stock which is typical of those found plastered all over the bulletin boards, the reason that this increases risk is obvious.

If there has been a major buying interest for example, because of some newspaper tip or other news item, then there will be a high percentage of uninformed beginners, novices, addicted gambling junkie type losing traders, and all other forms of these people pilling into longs, usually at well above “healthy trade size” for their guts to withstand.                                                                                                    

They will be sitting at their screens on edge and high on adrenaline. If the stock has had a large rise already, and then there is some weakness in the overall market, you can expect to see them sell off very hard and fast, as the main move has been caused by these very nervous characters buying more than they can comfortably afford.

How many times have you seen or heard someone say, “All the leaders are down?” Well this is the reason!                                                        

If you want to run a low risk portfolio, it is not advisable to have too many of these stocks!

 

  Liquidity risk

 

In particular this kind of risk can be often observed in bear markets in small cap stocks, as most shareholders wish to sell, and the market makers don’t want to buy this stock, they widen their spread to increase their profits made from two-way trading, and also to deter people from selling.

 

  Human error/discipline risk

 

Sometimes people make mistakes, and sometimes cannot stick to the rules.

Trading if tired, or under some external pressures, or failing to listen to internal warnings, can lead to catastrophic failures of judgement causing extreme losses!

 

  Computer failure risk

 

Always have more than one way to access prices, because even though computer or power failures are rare, there is no reason why a trader needs to expose himself to additional risk, and not install some form of emergency source to keep track of his positions. Consider it as wearing a seat belt or not....it only takes a second to do, and can save your life.

 

  Protection against risk

 

Market risk is the simplest risk to protect against.

This can be done in several ways.                                                                                         

If the portfolio has mainly long trades, then simply having a stop to sell the FT-SE 100 futures, at a given level maybe 100-200 points down, placed with a spread bet company that offers 24hr service can suffice.                                                                                                              

In the event of weekend / holiday protection being needed, one can either, take a long position in some Index put options, sell some call options (above the market), sell index futures just before the close on Friday and purchase them back on Monday morning.

A more efficient method however, lies with having a more even balance of shorts and longs in place. The more close to market neutral we become, the more we reduce market risk.

Idiosyncratic risk can never be removed, but it can be reduced (as far as the effect it has upon the trader’s portfolio) by increasing the number of trades that we have open at any time, and also by reducing the size of the position each instrument held.

Also, by being prudent at reading charts, trends, and company health, this can be reduced.

Liquidity risk, as above cannot ever be eliminated, but it can be reduced also by increasing both the number of trades, and by reducing the number of trades done with very small capped companies. This also becomes a problem when a trader has a lot of equity, and will find fewer and fewer stocks that can absorb large volumes.

Download the full article here

 

  How much to risk on each trade?


Experienced traders know the importance of risk control. If you risk little, you win little. If you risk too much, you will eventually wipe out your account.

The optimum, of course, is somewhere in between........read more

                     

 

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