Price Risk Management Methodologies
A ship in harbor is safe, but that is not what ships are built for.
—John A. Shedd
Nobody goes into an investment hoping its value will decline and it will one day be worth less than what was paid for it. This chapter examines the development of price risk management methodologies and shows why positive expectancy trading models as standalone solutions are insufficient for success as a trader. Specifically, the chapter explores the full array of methodologies, including stop loss placement, volumetric position sizing, Value-at-Risk, stress testing, and management discretion. Particular emphasis is placed on combining these various tools to generate robust price risk management solutions.
ONE SURE THING
In speculative trading, many are obsessed with pursuit of the elusive sure thing. Chapter 1 specifically addressed the development of positive expectancy models because they are the single most important ingredient for success as a trader. But even the most robust positive expectancy models cannot guarantee a profit on every single trade. In fact, the only sure thing—aside from the cyclical nature of volatility, which is examined in Chapter 4—in trading is that there is no sure thing. Since there is no such thing as a sure thing we must assume that each and every trade we take will be a loss. In this manner, we are always prepared for the worst and can never be surprised when the worst occurs.
Many traders find this expect-and-prepare-for-the-worst ...