Red-Blooded Risk: The Secret History of Wall Street

Trading Risk

I will describe front-office risk management of traders because that's the type I've had the most experience with. The traditional part of this job consists mainly of watching the traders for telltale signs they are taking too much or too little risk. You set limits that are tailored to the individual, position sizes they can hold on their own, sizes that need your approval, and sizes that have to be approved by the desk head. There can be different limits for different types of positions, for intraday versus overnight positions, and so on. You expect people to use their limits. If their positions are consistently much smaller than the levels allowed, you find out why. Seats at a trading desk are valuable, and traders must take risk in order to generate an adequate return on investment. Of course, people who are over their limits are a concern as well. Even the slightest hint of disguising risk, such as “putting trades in a drawer,” meaning making a trade that the firm is liable for but not reporting it in the trading system, is grounds for immediate dismissal.

Experienced traders who go into front-office risk management learn how to spot traders holding losing positions out of pride or stubbornness rather than calculation, or taking profits early out of fear or greed rather than sober judgment. The risk manager gets a sense of when someone is too reckless as a result of recent big swings, either up or down. The same swings can make a different trader too cautious. ...