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

Preface

I started learning about trading strategies and managing trading risk while working on statistical arbitrage trading desks at two investment banks—first at JP Morgan and later Bear Stearns. The core of the job was converting some type of analysis into an action. In other words, I had to use data to make a decision and think through the effects of those decisions. Over time, that most risk management is focused on analysis rather than making decisions. In most risk management texts, there is very little discussion on what decisions are made as the result of analysis.

My first exposure to risk management came when I worked as a programmer on JP Morgan’s proprietary trading desk in the early 1990s. Just before I’d taken that job, I’d left my job at a computer game company and needed a short-term job to pay the bills. At the time, I intended it to be temporary and lasting long enough for me to raise enough capital to start my own company. My life would have taken a different turn had I ever managed to get that IPO completed. Instead, I was sucked into the world of trading and risk management. I started off as a junior programmer focused on implementing a new approach to managing risk on a trading desk called “value at risk”.

The goal of that first job was to give the CEO of JP Morgan, Douglas (Sandy) Warner III, a summary that told him “how much money does the firm have on the table” within 15 minutes after the close of trading. This report was to be short—something that ...