Understanding Risk Management
Basic risk management
Understanding the risks of each transaction
Understanding of market risk
Risk to reward ratio and the Pareto principle
Risk management or self-employed person who works in strategic areas, each day dealing with the bad road conditions. Someone could have been sure to arrive at the office on time. However,
of the conditions on the street no one knows, for example, a tree
felled by the previous rain, or the road is closed, or other factors
which may cause obstruction of the trip.
The person's ability to manage uncertainty in the streets is one form of risk management.
Similarly, the financial world. Risk is the uncertainty that would occur from each situation and the decisions we take. It's just that the consequences of that risk management is reduced or loss of our funds.
Risk management helps you to identify any risks that might face and what are the ways that need to be prepared to deal with it.{Break}Risk management is important to noteIn
trading, risk management is needed, because the risks are of course
many many types of risks that exist in nature that you are always
lurking in trading activity. Two important risks are:
A. Risk management trading / trade
Management
of trading risk is the risk you take when determining how much capital
and volume of transactions that are involved in every decision. The risk of this type is fully under your control.a. Total equity risk
Professional
risk management is usually advocated total risk is limited to a maximum
of only 20-30%, if you are confident enough, then you can customize it.
b. The risk per time entry position
Once you determine the equity risk limits, risk management then stop losses can be determined. Methods for determining stop losses varied. But should you have to look at risk management from total equity.Table 1 below gives an overview of risk management, that the more risk you take, the fewer transactions can be executed. If you want to use 1% of the total equity in each transaction, then you have 100 times the chance of a transaction. If you choose 5% of total equity, you will have 20 chances. This is necessary in order to consider risk management you can find a suitable reward risk ratio.risk managementTables. 1 Comparison of risk per transaction and opportunityIn these tables, it can be seen that the greater percentage of the risk, it has narrowed the number of opportunities we have. Many
parties, suggested risk management must not be greater than 2% of total
equity per transaction, so that even if an error occurs 25 times
consecutively, you still have 50% equity to be able to restore the
performance of trading.{Break}2. Market risk
Management of this risk is the risk that has been owned by the market itself, both before and after you get involved in it. You absolutely can not do anything against this kind of risk, except to know to analyze and seek to overcome them.
Each instrument has unique trading, risk management 3 most important things you should consider are:
Price changes and volatility
The first and most basic is the market price changes. These changes will certainly create its own risk management for your trading activity. Berkapital large stocks that typically move more stable than a small berkapital. Forex and the index is the same, some of the index and currency moves more stable than others.
High
volatility, particularly if accompanied by a large range of movement,
can force you to loosen limits the risk that you specify, such as risk
management by placing the stop loss further.
Liquidity risk
To liquidate stock positions, usually in the input data will be in the queue list. If the market is down, and hard to find a buyer, you may not be able to liquidate a position to override your great loss. Such
risks should also be considered in risk management, and find ways to
cope with losses that may arise, you can be, for example, do the shot
sell (if possible) or a hedge in the futures market or CFD markets.
Liquidity
risk management instruments such as this for futures or other
derivatives are minimal, especially after the introduction of online
trading activity, which enables the implementation of electronic
transactions.
Leverage and risk margin
Leverage risk can be defined as risk management arising from the use of a larger scale than the capital paid-in capital. For example you can buy or sell an instrument worth $ 100,000, - with only a deposit guarantee fund of $ 1,000. The
guarantee is not a maximum number of losses if the market moves against
your position, but most of the total capital that you deposited also
bear the risk. This happens because the leverage loan fund contains and we must pay to the broker if the deal goes bad.
Overnight risk
Futures for risk management instruments, you save a position overnight. Specific news can cause the market to move in the desired direction, or vice versa. Sometimes, you can not save the order of liquidation when the market closed. Saving overnight position is to consider risk management.
Examples: for Lehman Brothers (LEH). The day before the announcement of bankruptcy, LEH stock price closed at $ 4.00. On the day of insolvency, LEH opened at a price of $ 0.24. This decrease amounted to 94% in a day. Positions will result in tremendous gains in the day, otherwise the position would undermine the overall capital purchase.{Break}Assumption of risk management that need attention
In
preparing the risk management, there are three things you need to
consider as a base for your risk management, the first is the risk to
reward ratio, the second is a win loss ratio and the third is the Pareto
principle.
A. Risk to Reward Ratio
Risk management is a ratio used to compare the potential benefits to the risks in any decision-making transaction. Risk
reward ratio in this case different from what is generally understood,
in terms of trading is very simple to use as an overview of risk
management that you will take to get a certain number of advantages.
For
example, if you have a risk reward ratio of 5:1, it does not mean that
you actually receive benefits five times greater than the risks. Once again that this is a ratio rather than fact.
To sort the risk reward ratio for each person will vary and are subjective. Investors have capital will have a level of acceptance of risk is greater than the small investor. Other personal factors of risk management, such as the purpose, character and age are also influential in setting the ratio.
To
adjust the ratio to the risk management transaction activity is not too
complicated, there are many ways that can be done, for example by
changing the composition of capital, stop loss, or even by changing the
exit point.
Develop your own ratios
Preparation of risk management reward need not be complicated, even very simple. You only need to answer two questions below;
How much profit do you want from each transaction? How much money you're willing to put at risk to benefit them?
After
you answer it, divide the amount of such benefits against the amount of
risk you are Let go, and the results you have obtained your own reward
risk ratio.
2. Win Loss Ratio
This
ratio is intended to measure how big a percentage of wins versus losses
of risk management generated by your trading system.
To
get it, you certainly must have a risk management system in advance,
draw up the system and test results are either in the form of back
testing or forward testing using a demo account.
You can also do a visual test via a graph if it's easy to do. After that, write down the number of times the system is making a profit and how many times result in failure. Thus risk management you have to get a win loss ratio.{Break}3. Pareto Principle
"Vital few and trivial many". Pareto principle says that 20% of something is always paid off 80%. Or
in other words, 80% of the results obtained from the 20% activity, and
20% of the results are always obtained from the 80% activity. In terms of trading, the effective profit comes only from a fraction (20%) of your transaction activities.
You
do not have to adopt this principle is exactly the figure, the most
important thing we must understand is that most of the trading activity
typically contributes only a small part to the growth of our capital.
For example, risk management, say, a method has a probability of 60% and a whopping 40% victory. Principles above can be run as illustrated below;
10 Transaction EUR / USD, every transaction has a 50-point SL and TP 100. 6 of the transaction is exposed to stop losses and yield losses, 4 others make a profit.
Loss Transactions 6 x 50 points (pips) x $ 10/poin = - $ 3,000
4 Transaction Profit x 100 points x $ 10/poin = + $ 4000
Net Profit / Loss = + $ 1,000
That means that by managing your trading risk management, though still poor methods you can use to generate profits.
Review
When
trading, the things you need to consider in risk management is how much
of your total wealth are you prepared to put at risk. (Suggestions in general ¬ ranged between 20% and 30% ..
Another
thing to note are when trading is risk management price movements,
volatility, risk and risk margin for open positions overnight
Risk to reward ratio will provide a comparison of risk management is taken to the profit generated.
