Risk Management in Trading: Techniques to Drive Profitability of Hedge Funds and Trading Desks

CHAPTER 1 Trading and Hedge Funds

This chapter introduces how trading organizations, such as hedge funds or the proprietary trading desks of investment banks, apply risk management concepts to operate their businesses. Risk is uncertainty or a potential for loss. Risk isn’t necessarily bad. Risky activities often provide higher profits than safe investments. Techniques developed to manage risk are used by trading desks to drive profitability by balancing risk and reward. Some of these techniques include choosing the most profitable investments, allocating a limited amount of money between multiple investments, eliminating risks through hedging, and assigning size limits to various investment strategies.

There are a limited number of decisions that can be made by trading desks to manage risk. Profitability starts when traders do a good job identifying investment opportunities. After that point, common decisions are: how to allocate capital between investment opportunities, limiting how much money is allocated to any single investment, and reducing the size of investments by liquidating or placing protective trades.

OVERVIEW OF BOOK

This book describes how risk management techniques are used by professional traders to reduce risk and maximize profits. The focus of the book is how traders working at hedge funds or on investment bank proprietary trading desks use risk management techniques to improve their profitability and keep themselves in business. However, these techniques ...