Risk Management in Trading as explained by Peter L
Brant
Successful
trading operations are dictated primarily by how risk is managed. Many novice commodity traders assume each
trade will be a winner. Professional
traders manage their trading to assume that each trade may be a loser. Obviously,
there is a major difference between the two perspectives. The Factor Trading
Plan operates with several global assumptions, including:
I have no idea
where any given market is headed. I may think I know, but in reality I do not know.
History has shown that my degree of certainty about a given market’s direction
is inversely correlated with what actually happens. In fact, I think a trader
with excellent money management practices could take the other side of trades
in which I have a strong belief and make money consistently.
About 60-70
percent of my trades over an extended period of time will be profitable.
As many as 30-40
percent of my trades over shorter periods of time will be unprofitable.
There is a high probability each year that I will
incur eight or more losing trades in a row.
There will be losing weeks, losing months, and even
losing years in my trading operations.
Important risk
management guidelines have been incorporated into the Factor Trading Plan to
address these global assumptions. The
primary guideline is that the risk on any given trade is limited to 1 percent
of trading assets, and preferably closer to half of 1 percent of assets. Because
I think in incremental units of $100,000, this means that my risk per trade per
unit of $100,000 is a maximum of $1,000. My trading assets committed to margin
requirements rarely exceed 15 percent. I don’t recall ever receiving a margin
call for the account used to trade my full program. If I risk 1 percent of assets
per trade and am wrong eight straight trades at least once each year, it means
that I will experience a drawdown of at least 8 percent with certainty, at
least on a closed trade basis.
A 15 percent drawdown is about as much as I can
emotionally handle.
I have encountered a drawdown of at least 15 percent in 9 out of every 10 years
I have operated a fully implemented trading program. I find myself more risk
intolerant as I grow older. At the present time, my risk management protocol
attempts to limit the maximum annual drawdown to 10 percent (measured from
week-ending peak to week-ending valley). I attempt to ignore intraday equity
spikes because I have no desire to catch the bottom of each day’s high or low,
and I do not want to waste energy in even thinking about it. In fact, as I will discuss in this book, I think
it is unwise to pay attention to account equity levels on a day-to-day basis. I
consider correlation between markets when determining risk. For example, a
bearish trend by the U.S. dollar against the euro is also likely to be
accompanied by U.S. dollar losses against the Swiss franc and British pound. A
bull market in soybeans is likely to be accompanied by advances in soybean oil
or soybean meal.
In composite
positions of highly correlated markets (grains, interest rates, stock indexes,
currencies, precious metals, industrial commodities), I attempt to limit my
risk to 2 percent of assets. All successful trading operations must be built on
a foundation of overall risk management.
