Why only 1% Capital Risk when trading

[Gardan]

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

TheBramble or The TheBramble has started a thread on disaster planning, which if he has not started it to stop me beating him in the T2W awards next year. I think links in quite nicely with this thread.


http://www.trade2win.com/boards/showthread.php?t=13310

 

[Gardan]

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

Thanks Mr C, Who is Roger M, it's not the Saint is it? I met him once skiing, a few years back, in a small Hamlet in Switzerland called Villars, he has a pad there.

I never spoke to him about trading but he didn't seem the type of bloke who might be interested in the markets?

Never can judge a book by it's cover hey!

Gary

 

[Mr. Charts]

Hi Gary,
Privmail him. He is also the options forum editor.
You can rely on anything he says as being correct , factual and practical - not the guesswork, supposition, speculation, or comments that "sound" right and convincing on BBs, but are recognised by the competent and experienced as being just plain tosh.
He'll turn red when he reads this
Richard

 

[TheBramble]

Richard, Socrates is on vacation for a couple of weeks as you well know and I find it a little childish for you to pillory him when you know he can't defend himself.

 

[TheBramble]

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.

As stated elsewhere Gardock, I managed to create my own personal 9/11 on a couple of occasions. The first couple of forays into trading were doomed by under-capitalisation, lack of basic skills and knowledge an a complete absence of and Risk or Money Management.

Ignored stops, let losses run - normal sort of stuff.

Aggressive? Yes, but not by design. In hindsight it was simple stupidity.

 

[Salty Gibbon]

Hmmm

I seem to be losing the thread of this thread.

Is Roger M = Socrates then or have I missed something ?

Bloody weird website this is at times.

 

[Gardan]

Hmmm

I seem to be losing the thread of this thread.

Is Roger M = Socrates then or have I missed something ?

Bloody weird website this is at times.

Dunno Salty, I just tink, your mad. It's better than corrie though!

Guess he ain't the "Saint" then?

 

[Gardan]

typo

PLEASE, PLEASE,PLEASE, Lets not kill yet another thread with a multi nick's saga.

I getting to the point where I don't give "Two Flying Swans" on this subject.

 

[Gardan]

D'Brumles

As stated elsewhere Gardock, I managed to create my own personal 9/11 on a couple of occasions. The first couple of forays into trading were doomed by under-capitalisation, lack of basic skills and knowledge an a complete absence of and Risk or Money Management.

Ignored stops, let losses run - normal sort of stuff.

Aggressive? Yes, but not by design. In hindsight it was simple stupidity.

Tony, Re the under-capitalisation bit, is it fair to say that as a trader builds up his pot of lolly. He/She may have to take a few more risks with there capital (not with there stops). Say, risking 5% -10% in the market, until the pot is large enough to use your more prudent risk management?
If not how will the trader survive trading prudent small amounts, without getting nailed by all the fees.

I'm guessing the answer may be :
Start with a big pot or take bigger chances and hope nothing bad happens reducing your risk along they way?

What's the biggest killer of Traders, that make up the stats of 95% failure (even if it is not that, probably fair to say it is high).

Not using Stops?-under-capitalisation- ect. ect.

Gary

 

[DaveJB]

Bimble,
your #64 has me wondering if a post got pulled, or you were being typically cheeky in supposedly assuming that Richard's previous comment automatically identified a fellow poster.
(Hmm, think I nailed that one...)
On risk, sizing, etc - there is no requirement to size a position on the supposition that all holdings will zero on catastrophe, provided you either have a reasonably diverse spread of holdings or you only have part of the total pot in the market at any one time. If you had 20,000 in your pot, and put all 20k into 5 stocks from the same sector of the Nasdaq (for example) then your risk is significantly higher than if you had 10 holdings of 2K each, spread over the FTSE, DAX, CAC, NYSE and NASDAQ in different industries/sectors.

The bigger your pot, the smaller the return needed to accomodate a nice lifestyle - although it's a bit harder to buy $1 Bn in most companies due to the pressures of suddenly becoming CEO of Microsoft etc. Personally (and no doubt wrongly) I do this sort of thing by 'feel' - I make sure that if everything zeroes I can afford to pay the bill for any margin incurred - when buying shares/shorting shares the worst that happens is I lose what I invested (long) or have to pay out the price of the price drop (short) - it would be a once in a millenium event, if you had ten holdings, for more than a couple to do this at once - a general market collapse like 9/11 will perhaps halve everything - you should, IMO, as a matter of course, assume something like 'all share prices halve faster than I can react' as the worst case scenario, and invest on that basis.

To invest on the idea of 'all prices zero' is too cautious - if that happened then money will cease to have value anyway, as nobody will be in business any more.

For Grandiron, who maybe didn't experience 9/11 as a trader, and has hopefully not been holding long when a company posts an earnings surprise of the wrong flavour, you need to always bear in mind that companies can and do drop by 30-50% on profit warnings, and it's blue chips doing it sometimes, so personally I'd say you should always limit exposure to the extent that you MAY have at least a couple do it simultaneously - so you don't want to have to answer margin calls at that point that require you sell the house.

Dave

 

[DaveJB]

Oh, I should perhaps also note that I tend to agree with Theresa Lo, who opined (I misquote dreadfulyl here) that the 1% or 2% rule is too tight - she suggests 5%, on the grounds that if you are wrong 20 times in succession then you probably ought to rethink your strategy. More cash in the pot returns more income for less risk, so I'd tend towards conservatism the richer I got... I'll let you know if I do when I manage it <g>
Dave

 

[Gardan]

To invest on the idea of 'all prices zero' is too cautious - if that happened then money will cease to have value anyway, as nobody will be in business any more.

For Grandiron, who maybe didn't experience 9/11 as a trader, and has hopefully not been holding long when a company posts an earnings surprise of the wrong flavour, you need to always bear in mind that companies can and do drop by 30-50% on profit warnings, and it's blue chips doing it sometimes, so personally I'd say you should always limit exposure to the extent that you MAY have at least a couple do it simultaneously - so you don't want to have to answer margin calls at that point that require you sell the house.

Dave

Dave, interesting points, look forward to a few views on the points you have raised.
Re: 911& profits warnings no to both but this thread has certainly made me aware of them.

Re sell my house, I dont have one, the wife just lets me sleep here and help with the bills.

Gary, (I think??)

 

[Salty Gibbon]

you should, IMO, as a matter of course, assume something like 'all share prices halve faster than I can react' as the worst case scenario, and invest on that basis.

To invest on the idea of 'all prices zero' is too cautious - if that happened then money will cease to have value anyway, as nobody will be in business any more.

Tend to agree with this.

A sensible and prudent middle ground.

 

[TheBramble]

Tony, Re the under-capitalisation bit, is it fair to say that as a trader builds up his pot of lolly. He/She may have to take a few more risks with there capital (not with there stops). Say, risking 5% -10% in the market, until the pot is large enough to use your more prudent risk management?
If not how will the trader survive trading prudent small amounts, without getting nailed by all the fees.

I'm guessing the answer may be :
Start with a big pot or take bigger chances and hope nothing bad happens reducing your risk along they way?

Yes and No.

If you're starting with a liquid assets base which doesn't allow that level of caution, yes of course, you'll have to be be hitting a much higher percentage. But then again, there's a difference between trading successfully small with a small capital base - and trading wildly with a small capital base because you need the income.

The transition from paper trading to cash trading should IMHO be with a very small position size. So small, that costs barely allow you to B/E. That way, you get used to the real world of slippage and bad fills and real market action. Stuff that NEVER happens when you're paper trading.

What's the biggest killer of Traders, that make up the stats of 95% failure (even if it is not that, probably fair to say it is high).

Not using Stops?-under-capitalisation- ect. ect.

I don't know if that figure is high or not. But I suspect running losses, cutting profits, expectation/hope, too early/late, assumptions, no risk or money management and trading too much of the pot. This has been covered to death elsewhere, but bears repeating I guess.

 

[TheBramble]

To invest on the idea of 'all prices zero' is too cautious - if that happened then money will cease to have value anyway, as nobody will be in business any more.

It's interesting that your comment and Salty's comments have got me thinking about my disaster strategy.

I am a probability type. Love the stuff. I KNOW my position is never going to hit zero. (Or rather, the probability is so low as to not be worth thinking about). I have a really good 'feel' for roughly how things are likely to pan out.

But here's the thing. If I had ALL my liquid assets in my brokerage accounts (rather than just 10%) and a really strong setup occurred and the signs were all favourable, would I really stick to 1% max risk - would I really stick to max 10%?

I'm not sure. Which is precisely why I operate the way I do.

Toward the end of this year (September) If I've been as consistent in my trading as I have been over the last year plus, I'll move my level up to 15%. No more than that though.

Too cautious? Maybe. But it's the way I currently find best suits my psychological profile and trading style.

I'm pretty certain it's going to be different for everyone.

 

[DaveJB]

Hi Gary,
not a lot substance to it really, but I'll have a go, and Grandiron was a nod in passing to Bimble ;-)

On 9/11 I had trades open - the markets shut (memory, perhaps false, insists they closed like steel shutters slamming down) and stayed shut for days... they reopened with a significant gap down. Now, short players did well there - I don't recall any arrangement to be fair about it, ie short players did well, longs generally got slaughtered, and there was no opportunity to get out as stops were ignored as the price jumped past. (Guaranteed stops excepted).

In a smaller way this happens with profits warnings, which are rather more common events - the one I remember best (I've not experienced many, thankfully) was Honeywell about 2001 or so... I had a long trade, it was trending up like it was trying to create a perfect 45-50 degree slope, closed around $40 one day and posted an after hours surprise that saw it open at something like $28 the next day. Bad enough holding it long in shares, a 30% or so drop but imagine if you had a spreadbet on it that was open overnight - that's a $12 or so drop, at the minimum £1/pt I' m used to currently that's a bet I'd have been looking to make maybe £50 from that suddenly turns into a £1200 loss!

That sort of thing can happen - there is a risk that any one share might plummet and cost a lot to get out of, and a stop won't necessarily work unless guaranteed or you have the opportunity to exit at the chosen price, gaps prevent this, and gaps are common - some of us scan for opening gaps as a daily trade opportunity so they're hardly uncommon.

It's a case of figuring out what it's possible to lose, and how likely it is to happen - a 9/11 event will perhaps halve all stock prices, so you could hedge against that by simply ensuring you have a reasonable spread of long and short trades - the shorts would hopefully compensate for the losses in the longs, or at least take the sting away... you can diversify your holdings and reduce risk by trading different markets and sectors simultaneously as well, so a big problem in say the drug companies only affects part of your holdings.

By spreading the risk you are limiting the number of events that can wipe you out . Over and above that you can take a significant hit to more than one stock at once, stocks in the same sector will often move together (you'd think that bad news for Tesco would be good news for Sainsbury really, but it doesn't seem to work that way <g>) so if stocks are closely related and you are long the pair then you stand more chance of having two big drops than if the two are unrelated - when did Tesco's results last affect Vodafone?

So, if you reduce risk by diversifying your holdings, and reduce it further by trading both directions, you are no longer (IMO) at 100% risk of loss - you may well get stung, but not fatally. If you then decide that maybe you'll estimate a worst worst case is a day where you can't exit and you lose 25% of your pot, I think you'd be nearer reality. If all shares lost 100% a 50:50 long:short policy should leave you neutral, provided everybody pays up <g> You also have to figure the economy and civilisation are going to hell in a handbasket at the time so what use is money, and bank accounts etc will disappear into thin air anyhow - money, and share prices, only have a perceptual value, other than a small real worth as firelighters or fishing weights. No need to guard against that then, is there?

There are probably people who can quote percentages on this, I'd suggest you want a sort of central loss% number then stick a 1-2 standard deviation band around it, statistics ARE useful, but stick your feet in the fridge and your head in the fire and they're still wrong about feeling okay on average.

Dave

 

[Gardan]

Hi Gary,
not a lot substance to it really, but I'll have a go, and Grandiron was a nod in passing to Bimble ;-)

On 9/11 I had trades open - the markets shut (memory, perhaps false, insists they closed like steel shutters slamming down) and stayed shut for days... they reopened with a significant gap down. Now, short players did well there - I don't recall any arrangement to be fair about it, ie short players did well, longs generally got slaughtered, and there was no opportunity to get out as stops were ignored as the price jumped past. (Guaranteed stops excepted).

In a smaller way this happens with profits warnings, which are rather more common events - the one I remember best (I've not experienced many, thankfully) was Honeywell about 2001 or so... I had a long trade, it was trending up like it was trying to create a perfect 45-50 degree slope, closed around $40 one day and posted an after hours surprise that saw it open at something like $28 the next day. Bad enough holding it long in shares, a 30% or so drop but imagine if you had a spreadbet on it that was open overnight - that's a $12 or so drop, at the minimum £1/pt I' m used to currently that's a bet I'd have been looking to make maybe £50 from that suddenly turns into a £1200 loss!

That sort of thing can happen - there is a risk that any one share might plummet and cost a lot to get out of, and a stop won't necessarily work unless guaranteed or you have the opportunity to exit at the chosen price, gaps prevent this, and gaps are common - some of us scan for opening gaps as a daily trade opportunity so they're hardly uncommon.

It's a case of figuring out what it's possible to lose, and how likely it is to happen - a 9/11 event will perhaps halve all stock prices, so you could hedge against that by simply ensuring you have a reasonable spread of long and short trades - the shorts would hopefully compensate for the losses in the longs, or at least take the sting away... you can diversify your holdings and reduce risk by trading different markets and sectors simultaneously as well, so a big problem in say the drug companies only affects part of your holdings.

By spreading the risk you are limiting the number of events that can wipe you out . Over and above that you can take a significant hit to more than one stock at once, stocks in the same sector will often move together (you'd think that bad news for Tesco would be good news for Sainsbury really, but it doesn't seem to work that way <g>) so if stocks are closely related and you are long the pair then you stand more chance of having two big drops than if the two are unrelated - when did Tesco's results last affect Vodafone?

So, if you reduce risk by diversifying your holdings, and reduce it further by trading both directions, you are no longer (IMO) at 100% risk of loss - you may well get stung, but not fatally. If you then decide that maybe you'll estimate a worst worst case is a day where you can't exit and you lose 25% of your pot, I think you'd be nearer reality. If all shares lost 100% a 50:50 long:short policy should leave you neutral, provided everybody pays up <g> You also have to figure the economy and civilisation are going to hell in a handbasket at the time so what use is money, and bank accounts etc will disappear into thin air anyhow - money, and share prices, only have a perceptual value, other than a small real worth as firelighters or fishing weights. No need to guard against that then, is there?

There are probably people who can quote percentages on this, I'd suggest you want a sort of central loss% number then stick a 1-2 standard deviation band around it, statistics ARE useful, but stick your feet in the fridge and your head in the fire and they're still wrong about feeling okay on average.

Dave

Cheers Dave, very informative.

re name thing. that's OK , whispering: I know that Bramble chap has difficulty spelling.


So lets say (when I grow up and am a big boy) I trade the NASDAQ intra day but not before or after the bell. Closing all positions daily.

I trade 4/5 shares each day some Long some Short. My risk is much reduced and there is no need to spread risk over other markets.

Re Guaranteed Stop Loss: What is this and how does it differ from other stop losses. Is IB's & DAE stop loss guaranteed (they seem to be popular brokers on this forum)

If one is to close at the end of each day is the risk reduced more against : Gaps-Suspensions-Profit Warnings.

As a side note: you mentioned Gaps, it's a topic I have been researching, you should start a thread, love to get more info on it!

Thanks Duved (sorry chaps, sure your bored with it now, last one, honest!)

 

[frugi]

If it isn't already obvious, Socrates is not connected with RogerM in any way.

***--end of moderate transmission-***

Yay, he cuts a dash!

Aaaargh....

 

[Gardan]

PLEASE, PLEASE,PLEASE, Lets not kill yet another thread with a multi nick's saga.

I getting to the point where I don't give "Two Flying Swans" on this subject.

Fear of repeating myself..... but come on guys please. the stuff you have supplied on this thread is possibly invaluable to me and others.

 

[DaveJB]

Hi,
sorry - busy night...
NAsdaq - your risk, in the case suggested, is that you are only exposed to the US market so it can crash mightily, turn your investments to dust, while the rest of the world could theoretically be just fine and carry on as normal. Having said that as a sort of standard disclaimer I'd say that trading is 'intellectually stimulating enough' that you simply can't devote 80% of your brain to hedging against what ifs. Ultimately the more eggs in the basket the better, provided you don't have so many that egg management interferes with your reason for being in the farmyard in the first place.

Diversification can be taken too far, in my opinion, and if you can say 'if this market I have a trade in halved in the next minute, would I be relatively okay with that?' then that's a decent rule of thumb. If a halving market - which is way worse than you would ever expect to see happen - would kill you off then you should look at maybe trying to get a more even long/short balance. I'd consider having two profit warnings, each costing up to 50% (the converse is also possible - somebody invents a cure for the cold and their shares double... not good if you have them as a short) as the most I'd expect to hit me in one go. Being able to handle that is probably more than you'll actually need. It's the risk:reward game as usual - overexposure to a catastrophe whilst having it all on red can be a big winner, but the damage is greater if the worst happens.

All that's just opinion of course, I survived profit wearnings and the like because when one share got hit it only had part of my money in it - if you had 10 shares and were fully invested then that might be a 5% overall loss... that won't take you out, it'll just sting a bit! A 9/11 event might take 50% if you are fully invested, long only - if you are 50:50 long/short you might well be untouched... so it's worth considering ways to keep invested but still reduce risk - using a range of tactics, some as simple as shorting, makes sense provided you don't complicate things tot he point your trading is rubbish.

Guranteed stops - you get them with things like spreads, I wouldn't be surprised to find them on offer in other areas - when I make a bet the company put a stop under it, usually a laughably big gap away so I then set it much closer. I could pay a slightly bigger spread and if the price gaps past my stop the SB company should honour the stop I set, despite the fact the price fell past it.
I don't use this myself, not least because the stops are limited in how close they can be to the current price, and they insist on too big a gap frankly - so I watch the screen, write my stops down as the price moves, and exit manually. They would be more useful to me if I held overnight, as a gap the wrong way could cost a few bob!


Gaps - not as excited by it as you <g> I'm interested in them for support, resistance, their tendency (quite often) to be filled, and the way the MMs generate them to take advantage of the herd at the open.

Dave