Trading Systems and Methods, 6th Edition

CHAPTER 23Risk Control

Anyone who has never made a mistake has never tried anything new.

– Albert Einstein

Every trading style has losing streaks that will ruin an investor who begins trading at the wrong time or is undercapitalized. The size of the position, the markets to trade, and when to increase or decrease leverage become important for financial survival. Systematic risks are those that can be controlled or reduced, while market risk, which can take the form of a price shock, can never be eliminated. As Andrew Lo said, “Risk is measurable but uncertainty is not,” and “Opportunity lies in uncertainty because everyone that understands risk can squeeze out every bit of marginal return.”¹

This chapter covers a broad range of topics related to risk, including individual trade risk, collective risk, leverage, and more on the effects of price shocks and catastrophic risk. Portfolio risk is discussed in Chapter 24. It is not possible to say that one is more important than another. In a specific situation, any one of these areas may hold the answer to preventing a substantial loss. The first part of this chapter discusses capitalization and shows why many traders are successful for months and then lose everything in only a few days. It explains the choices in dynamic leveraging and offers alternatives of less risk. Profit-taking and stops, the two most common ways to control risk, are shown to apply to specific types of trading, but not as a generalized solution. The last ...