Chapter 4

Controlling Risk in Vibratrading

In order for a trading methodology to be of any practical use, it must address the serious issues associated with risk in the markets. The true acid test of any long-lasting and robust trading methodology undoubtedly lies in its ability to effectively curtail the level of risk experienced by the portfolio, especially in drastic market downturns, including any Black Swan or Fat Tail events that may unfold rapidly.

This purpose of this chapter is to introduce the techniques and strategies used for controlling risk in vibratrading. Later chapters will provide a more detailed treatment on the construction and actual implementation of each of the specific risk control mechanisms mentioned in this chapter. We shall first list the types of risk that exist in the market, followed by the various control mechanisms that may be employed to manage those risks.

Types of Risk

Generally, the word “risk” refers to several risk-related characteristics of a trade vehicle. High volatility leads to adverse price gapping and limit moves, while high leverage can lead to reckless over-exposure. Illiquidity is another risk, leading to serious trade disruptions. In the case of market shocks, low diversification can result in increased vulnerability. A high capital requirement, as its name implies, requires a larger capital exposure and thus, greater risk.

As far as vibratrading is concerned, there are five types of risk that may affect any portfolio or single ...

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