# RISK



## tech/a (25 March 2006)

When you mention Risk most peoples eyes glaze over. I know mine did.

But whether youre in Business,Property,Just going about daily life or trading---RISK is constantly there.

For me its a pet topic,some years ago I learnt the risk of not understanding RISK.



> The biggest Risk of all is not taking any






> Find Risk and you'll find opportunity





Recognising,understanding,quantifying and making Risk work for rather than against you will be the single most positive thing you can do for your endeavours in creating financial security.

I wont have the time nessesary to devote to the topic this weekend but will return to discuss when I can. In the meantime I'm hopefull that this may generate some constructive discussion.



> The greater the risk the greater the reward




*One well heeled quote I dont agree with!!*


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## Milk Man (25 March 2006)

Definitely interested in what some of you more experienced guys have to say about risk, particularly in business and/or investing in general. 

Whenever I get into a discussion about trading with someone I always say that risk/money management is the most important part. This is something that confuses most of them as they generally think 'winning' would be the most important part. Thats probably why when the ripped skin report says it gets 70% winners or whatever, they get subscribers.  
For me its about quantifying, managing and minimising risk while maximising reward. Nicks low risk position sizing system has been a godsend to that end; what else can we use?


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## bullmarket (25 March 2006)

I mitigate investment risk through diversification and fundamental analysis (as I described in other threads).

Nowadays I invest with income as my number 1 priority and with my current risk profile I am invested only in LPT's and energy/infrastructure trusts for their high yields.

I mitigate my risk to LPT's by restricting myself to those that meet my criteria which include having no or very little exposure to property development, good quality tennants with long average lease expiry times and price/NTA in the 1.0-1.10 range.  

I'm now starting to also look at trusts that invest in the European property market for extra diversification and spread of risk.

cheers

bullmarket


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## nizar (25 March 2006)

Interesting thread

I remember reading an article about Warren Buffet and George Soros where risk was discussed.

The author was saying that while one thing to amateurs may be risk, to the experts there are no risks eg. a painter walking across a thin plank of wood from building to building - risky? but not so to him... eg. a stunt-master performing crazy moves on a motorbike - risky? not so to him, filled with experience...

Apparently it takes Warren Buffet 10minutes to analyse a company to see whether its undervalued or not. He bought some newspaper company for $80million, which was what the market valued it as. According to his calculation, it was worth $400million ie. if the company liquidated all its assets + intangibles + cash, etc, this was the value. If you ask him if it was risky, he'll say no... EVEN though he made a loss because the market did not realise this value until 2 years later....

George Soros made large bets against the UK pound, he didn't see it as risky, because according to him, the most he could lose was 4%..

So risk is definately different for everybody, but managing/minimising that risk is the key, especially for us mere mortals!!


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## tech/a (25 March 2006)

RISK is RISK.

Perception will always differ.
Tolerance will always differ.
As will methods of Mitigation.

As can be seen from the responses so far.


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## Knobby22 (25 March 2006)

tech/a said:
			
		

> RISK is RISK.
> 
> Perception will always differ.
> Tolerance will always differ.
> ...




Very True. Well said.

Risk is not very quantifiable.
It takes experience and knowledge to be able to judge risk.
As you say, perception varies. You often see people in life taking huge risks for medium gains and ignoring almost risk free smaller gains. Soros took on the English pound, it appeared as a huge risk but he knew exactly what he was doing so the risk was actually small, it was merely an opportunity.

I have what I consider a medium tolerance for risk.
It is risk based on my perception as to the possible upside, possible downside and the odds of each. *And I do lose,* Over time I have lost less often but I still make bad decisions... but that is what risk is all about.

My mitigation technique is to take these risks over a number of companies.
I do not invest in foreign markets or use derivative products to obviate risk.
Some would say this is risky behaviour but I prefer to trust my judgement than spread it all around and get safe ordinary returns.


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## bullmarket (25 March 2006)

Hi knobby22

yes :iagree: with you in that risk can be subjective and difficult to quantify.

but one simple example of measuring risk I can give (in keeping with KISS )is calculating the potential reward to risk ratio as part of whatever other criteria you might have that have to be met before a buy signal is generated.

eg...say on a chart the current shareprice is 106c and the nearest historical support is at 100c and the nearest historical resistance is at 110c.

Personally I like the current share price to have a potental reward:risk ratio of at least 2.0 before I would buy.

And so in the above case the _potential reward _ is 110 - 106 = 4c
and the _potential risk _ is 106 - 100 = 6c

So the potential reward:risk ratio in this case = 4/6 = 0.666 and well below my 2.0 minimum.

But of course all this depends on where you interpret support and resistance levels and what minimum reward:risk value you choose.  

*Now you can expand on this concept * by including other criteria for a buy signal and weighting them according to whatever relative importance you place on them........eg......you might be using a combination of tests  including say the MACD and stochastic indicators, volumes, chart patterns and/or any other criteria you like.  

At any point in time you could then assign a value of 1 or 0 to each test depending on whether the criteria is saying buy or not, weighting them to their relative importance and then summing up the results of each test to come up with a final score.  Basically it's the concept I use in my fundamental's test. To rate the stock an overall buy the sum of the weighted test results would have to add up to at least 50, 60, 70% or whatever you feel comfortable is an acceptable level to minimise the overall risk for the trade/investment.  Now imo the cutoff parameters you use for the reward:risk ratio and the weights and sum of the weighted test results can really only be reliably obtained by paper trading or other form of simulation until consistant acceptable results are achieved.  

_Imo the sum of the weighted test results is to some extent quantifying the overall risk according to your personal parameters_ - all the required number crunching for the above examples can easily be set up in a spreadsheet. Doing all this by hand would be very tedious and time consuming.

hope this helps

bullmarket


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## Julia (25 March 2006)

Tech

Interesting thread - thanks for starting it.

For me risk is relative to my level of capital.  If I were under-capitalised I would be extremely conservative in my investments.  That is neither right nor wrong, but simply reflects my attitude towards always ensuring that I can support myself.  If I had, say, only the bare minimum with which to generate enough income to live on, then I would be very risk intolerant.

Julia


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## sails (25 March 2006)

tech/a said:
			
		

> When you mention Risk most peoples eyes glaze over. I know mine did.
> 
> But whether youre in Business,Property,Just going about daily life or trading---RISK is constantly there.
> 
> ...



Hi Tech,

Appreciate you starting this thread.  Taking on risk would have to be my biggest hurdle in trading and I need to beat it, re-direct it, or something...  Would really like to hear your thoughts when you have time...

Thanks,
Margaret.


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## dutchie (25 March 2006)

Bullmarket

That soup must be off by now.

Cheers 

Dutchie.


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## bullmarket (25 March 2006)

hi dutchie 



			
				dutchie said:
			
		

> Bullmarket
> 
> That soup must be off by now.
> 
> ...




I think you're right  - thought it was starting to taste a little funny but couldn't work out why    

I think I'll change that saying to _'see you in the swamp' _ 

Have a nice evening and remainder of the weekend.

bullmarket


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## dutchie (25 March 2006)

Bull

I think being in the swamp would be *riskier* than being in off soup!



WayneL

What is "the risk" in selling a put (for expectancy calculations).

I would assume it is the strike price minus the premium.


Cheers

Dutchie


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## wayneL (25 March 2006)

I've taken some posts out of this thread, this is too good a topic to have to close down. There is an "ignore" function on this board so if someone "gets on your goat", you don't have to read their responses

I sincerely hope no-one takes offence, and certainly none is intended. I'm just doing the job as best I can.

Cheers


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## wayneL (25 March 2006)

dutchie said:
			
		

> WayneL
> 
> What is "the risk" in selling a put (for expectancy calculations).
> 
> ...




Dutchie

The pure risk in a written put is similar to an eqivalent number of shares, except that you have recieved the extrinsic value of the option as premium.

Therefore the risk is less than the equivalent share position.

However, the reward is capped and this must be taken into account when estimating _risk verses reward_ and hence expectancy. 

Each case will be different, depending on strike and expiry selected, volatility issues, and all those good things  

Cheers


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## wayneL (25 March 2006)

wayneL said:
			
		

> Dutchie
> 
> The pure risk in a written put is similar to an eqivalent number of shares, except that you have recieved the extrinsic value of the option as premium.
> 
> ...




Going on a bit, often written puts are described as having unlimited risk. Therefore straight shares, must also have unlimited risk. (It's not actually unlimited because you can't go past zero, but it is unquantifyable)

This is why folks use stops. Put writers can also use stops.

The difference being, shares also have "unlimited reward", whereas puts have a limited reward...sometime markedly so if IV's are very low.

Cheers


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## It's Snake Pliskin (25 March 2006)

Risk is amiguous in the classic sense. We can use nouns or adjectives to talk about it. What is it? Most don`t know, yet say "..it`s risky.." How many people say that to you when you tell them you trade stocks? Heaps I bet. 

Determining where the risk may be present is paramount. What risks are there? 
The risk of buying too high, not buying, making decisions on fundamantals or technicals, the risk of a company going bank rupt, the risk of a company falsifying reports etc, the risk of war, the risk of your computer blowing up etc etc.. Then we can look at the risks associated with your lack of psychological understanding. How does that affect one`s buying and selling, decision making etc? Is one risking too much on a trade? Is one risking too much due to leverage? Is one believing the higher the risk the higher the reward? 

It goes on.......


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## It's Snake Pliskin (25 March 2006)

bullmarket said:
			
		

> I mitigate investment risk through diversification and fundamental analysis (as I described in other threads).
> 
> I mitigate my risk to LPT's by restricting myself to those that meet my criteria which include having no or very little exposure to property development, good quality tennants with long average lease expiry times and price/NTA in the 1.0-1.10 range.
> 
> ...




Diversification is fine if done properly as part of a risk management strategy. The correlation of holdings, positions should be known to understand the risk being carried. If your positions are highly correlated then you are taking on too much risk. All positions behave alike increasing your drawdowns for example.

A way of mitigating this is too take some different holdings that may be construed as "risky" or "riskier" positions - once again ambiguous, but able to be determined. For example: having positions whose performance has no effect on other positions.

What one does not want to listen to and believe is that while one is going down it`s ok because the other is going up. Foolish and costly in my opinion. c: 

Cheers


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## It's Snake Pliskin (25 March 2006)

Julia said:
			
		

> Tech
> 
> Interesting thread - thanks for starting it.
> 
> ...




Yes, looking at one`s stage of life could impact on the risk levels taken. :cup:


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## bullmarket (25 March 2006)

Hi Snake 

re your comment:



> Diversification is fine if done properly as part of a risk management strategy.




yes I agree with you and the jist of the rest of the post I quoted from.

Imo that is what managed funds try to do, at least to some extent, in addition to their other objectives for the fund when they invest in Australian shares, OS shares, property, bonds, fixed interest and cash.

In my personal case I am starting to look at property trusts that invest in the European commercial, industrial, retail and leisure property markets because from what I am seeing the prospective yields are about the same as trusts I am invested in that invest in US property atm and a little higher than what the LPT's in Australia are averaging atm.

Also, since my number 1 priority is income nowadays I personally don't mind if one goes up a bit while another goes down.  Obviously I'd like all my investments to be going up at the same time all the time but that is just not going to happen and I certainly don't want to be spending hours on end doing research and analysis trying to find which sector/region etc is most likely to fire and risk getting it wrong. Mrs bullmarket already thinks I spend too much time on the pc as it is   

I (and more importantly mrs bullmarket ) are happy with the returns/income we are getting as they are meeting our objectives and I am reasonably confident that in say 5-10 years time the LPT's I am invested in will be higher in value, everything else being equal - how much? only time will tell but it's not my first priority.

cheers

bullmarket


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## tech/a (25 March 2006)

Do you honestly think trading various portfolios/or futures/or shares/or different groups of shares is Risk Management or even a form of risk management?

If I go to a Blackjack table and play blackjack for 2 hrs then play another 4 types of games say Craps,two up,Roulette,poker,I have in some way employed risk management through diversification?

Do you honestly believe that by trading 10 stocks rather than 1 that your risk has been mitigated?

If you drive a car every single hour of the day you LESSEN the risk of accident even though you change vehical every hour?

Do you believe that there is risk in jumping out of a plane with NO parachute?
Well risk is ZERO as you KNOW what will happen---you have absolutely NO doubt as to outcome.

Now Ive had enough of the lack of support from ASF and have mailed them accordingly--I'm also sick of Patronising from people who have little more than basic knowledge.
So I will watch with amusement as the un educated---educate.


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## 123enen (25 March 2006)

I'm just a simple man.
No one could ever accuse me of being a profound philosopher.

To me, risk (in terms of share buying) is simply the fear of losing money. 
To some people that would be a low amount of money and to others 
maybe more, depending on their financail situation.

It's about the impact your decision has on your peace of mind. 
So people do practical things to minimise risks. They do things that will increase their level of confidence in the decision they are about to make.

They may do fundamental research on a company, they may seek advice from mentors,they may trade only when a stock moves within an upward range. Additionally, they may set a number of parameters to help them make entry decisions and important exit decisions.  

As they do all this, they become more confident and feel less sense of risk, that is they feel there is less chance of losing amounts of money that would disrupt their peace of mind.

To me there has to be the probability of *tangible loss * for risk to exist. 
Losing an opportunity to buy into a stock because one waited for the price to get lower than it did is not an issue of risk. 
No harm was done - just a lost opportunity. No *tangible loss * occured.
Another opportunity will come along.


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## It's Snake Pliskin (25 March 2006)

> Do you honestly think trading various portfolios/or futures/or shares/or different groups of shares is Risk Management or even a form of risk management?




Only you know Tech! :nono: 



> Now Ive had enough of the lack of support from ASF and have mailed them accordingly--I'm also sick of Patronising from people who have little more than basic knowledge.
> So I will watch with amusement as the un educated---educate




No wonder people don`t want to contribute. I may do the same. ASF keep up the good work.


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## nizar (25 March 2006)

Snake Pliskin said:
			
		

> For example: having positions whose performance has no effect on other positions.
> 
> What one does not want to listen to and believe is that while one is going down it`s ok because the other is going up. Foolish and costly in my opinion. c:




Well said.

There has to be no correlation btw the 2 stocks/investments that u hold for the sake of diversification. eg. no correlation btw nikkei and s&p500...

ALso 2nd point very valid. I read something like this in a book about Warren Buffet's investing methods. Him and Soros basically dont believe in diversification. If they find a good investment, they put a considerable amount into it. If you spread the money around for the sake of diversification, u can't make the really huge gains.


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## stevo (25 March 2006)

It's nice if risk can be quantified. 

It's about the probabilities of something happening. What is the probability that I will lose money on the next trade, over the next year, or over the next 100 or 1000 trades? How would a strategy have performed over the last 10 years. 

If a strategy failed in the past then the strategy is highly unlikely to perform in the future. 

For me measuring risk, or determining the probabilities of success is about;
1. determining if the strategies I am considering using are likely to be profitable. I can really only do this through testing. 
2. Finding a strategy (or range of strategies) that have worked in the past, in out of sample testing, and eventually in actual trading.
3. determining a position sizing approach to capitalise on the strategy.
4. Monitoring results going forward.
5. Milking the strategy for all I can get given my trading business goals.

Where is the risk if you have done your homework properly? Thousands of hours testing and retesting strategies, analysing results, throwing out months of work because it doesn't make the grade, to come up with an approach to the market that tilts the probabilities of success very strongly (at the 99.95% significance level) in my favour.

What are the probabilities of failure if you don't do your homework?

stevo

http://drawdown.blogspot.com/


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## Julia (25 March 2006)

123enen said:
			
		

> I'm just a simple man.
> No one could ever accuse me of being a profound philosopher.
> 
> To me, risk (in terms of share buying) is simply the fear of losing money.
> ...




123enen

Agree 100%.  If what we are looking for is a clear definition of risk from a philosophical point of view, I don't imagine it could be better expressed.
So much to be said for not over-complicating the issue.

Tech
Not sure whether you were looking for the philosophical thoughts on this or the more sharply defined methods of assessing risk from purely a share market point of view?

Julia


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## 123enen (25 March 2006)

tech/a said:
			
		

> Recognising,understanding,quantifying and making Risk work for rather than against you




Not sure how you can make risk work for you. Surely if you could do that then there would not be any risk.


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## bullmarket (26 March 2006)

Hi stevo



			
				stevo said:
			
		

> It's nice if risk can be quantified.
> 
> It's about the probabilities of something happening. What is the probability that I will lose money on the next trade, over the next year, or over the next 100 or 1000 trades? How would a strategy have performed over the last 10 years.
> 
> ...




:iagree: 100% with your post and I think you hit the nail right on its head with your definition of risk. 

The points you mentioned are basically the premise I used when I decided to use the concepts I described in an earlier post in this thread regarding assigning weights, equal or otherwise, to one's criteria for both buy and sell signals.  I also agree with you, as I have said in other threads, that one's strategy should be tested and fine tuned if necessary by paper trading or whatever other simulation techniques you might have until the strategy's goals are achieved consistantly, however long that may take.

imo the more signals (obviously without going to ridiculous extremes) you have saying buy or sell the higher the probability is that in at least the short term the signal is correct and hence the lower the risk is to making a loss in the short term in the investment/trade.

Overall I have been happy with the returns I have received over the years using the concepts I described in earlier posts in this and other threads but that by no means suggests that what I do will be appropriate for all.....obviously it has been and will be for some and will not be for others.

cheers

bullmarket


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## Porper (26 March 2006)

tech/a said:
			
		

> When you mention Risk most peoples eyes glaze over. I know mine did.
> 
> But whether youre in Business,Property,Just going about daily life or trading---RISK is constantly there.
> 
> ...




Risk nowadays can be pre-set, especially with guaranteed stops.

I have never been a fan of divesification, to me it just means that you will never make a big capital gain.Always diluting your big winners.Thinking negatively, yes it will dilute your losers, but so what.

If I had $50,000 to trade with I could buy $50,000 worth of XYZ stock with a stop loss of 2% so the most I can lose is $1,000.This is my total risk.If the stock as hoped goes up, you could place the stop at breakeven very quickly, this then is a no risk trade (impossible to lose money, only breakeven or gain).You could then buy more stock (compound) as the price ticks up, this can be calculated with a trailing stop to again, never have any risk of losing any capital.

I am not advocating using all funds on one share, but the theory is still the same.Risk is always there but in this market we can calculate risk exactly if we wish.


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## nizar (26 March 2006)

Porper said:
			
		

> Risk nowadays can be pre-set, especially with guaranteed stops.
> 
> I have never been a fan of divesification, to me it just means that you will never make a big capital gain.Always diluting your big winners.Thinking negatively, yes it will dilute your losers, but so what.
> 
> ...




Well written

JUst one question though, is it possible for a stock to plummet so much that your stop doesnt get hit?


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## bullmarket (26 March 2006)

Hi porper 



			
				Porper said:
			
		

> Risk nowadays can be pre-set, especially with guaranteed stops.
> 
> I have never been a fan of divesification, to me it just means that you will never make a big capital gain.Always diluting your big winners.Thinking negatively, yes it will dilute your losers, but so what.
> 
> ...




I can see what you're getting at and my interpretation of your post is that:

*The higher the risk = the higher POTENTIAL reward* and not necessarily guaranteed reward which I believe most will agree with.

Imo investing the whole $50k in one XYZ stock is technically a higher risk investment than spreading it over say 5 stocks with the same potential prospects as stock XYZ.  Even by putting $25k into two similar stocks means you can still have the same potential total gain if they both shoot up or you can still have a nett gain if one shoots up and the other falls to your 2% stop loss level.  And if they both fall to your 2% S/L level then your loss is the same as you would have suffered had you only invested in one stock.

_So I suppose how far one diversifies firstly depends on how much capital they have and secondly on how much of that capital they want to expose to one stock, sector, market, asset class or global region._

eg.....in the current ASX share market game mrs bullmarket and I are holding a total of 7 stocks which are netting a positive gain atm (some stocks are up, some are down) at about the national average.  Sure, our nett gain would be much higher if we invested the whole $50k for the game in the best performing stock. 

However, one point you make that I disagree with is: 



> If the stock as hoped goes up, you could place the stop at breakeven very quickly, this then is a no risk trade (impossible to lose money, only breakeven or gain).




I disagree it is impossible to lose money in this case because I see paper losses as real losses......others for their own reasons don't see paper losses as being real and that's fine, each to their own on this one   But I accept paper losses could be much more relevant to a day or short term trader than say a long term investor.

eg.....if your $50k trade entry rises say 5% or whatever and you then watch it fall back to your original $50 and close out then sure, you haven't lost any original capital but imo you have still lost that 5% rise of which you had the option to close out on if you chose to, everything else being equal.

Imo, what you are saying in the above extract is that if on Eddie's show a contestant gets the $1M question wrong and then drops back to $32k that he/she hasn't lost $468k when in fact they had the option to take the $500k.
Imo that contestant in one instance had $500k secured in their pocket and then blew it and effectively lost it.

cheers

bullmarket


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## bullmarket (26 March 2006)

Hi nizar



			
				nizar said:
			
		

> Well written
> 
> JUst one question though, is it possible for a stock to plummet so much that your stop doesnt get hit?




just in case porper doesn't get a chance to reply, with Commsec conditional orders it is theoretically possible in rapidly falling stocks that your stop loss order will not get executed even after your trigger price is reached....ie...you could be very unlucky in that once the trades fall below your trigger price the highest subsequent bids could still be below your set 'execution' price  and so your sell order would not be executed unless the bids came back up to your sell/execution price.

cheers

bullmarket


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## Porper (26 March 2006)

bullmarket said:
			
		

> Hi nizar
> 
> 
> 
> ...




Maybe I didn't explain well enough, but with regards to the stop losses being guaranteed, I was infact referring to CFD'S where the stop is 100% guaranteed.So if your stop was set at one dollar and overnight a profit warning is sent out to the market and it opens next day at 0.70c, you will still get out at one dollar.

With normal trading I am not sure whether you can trade with guaranteed stops, in new Zealand you certainly can't.


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## Porper (26 March 2006)

bullmarket said:
			
		

> Hi porper
> 
> 
> 
> ...




Hello Bullmarket,

I don't see that investing all your capital in one company with a stop loss of 2% is any riskier than investing all your capital in 20 companies with a 2% stop loss on each.The set risk is the same(The hard dollars).Again I am not advocating this as a trading style, just that the numbers will be the same, in theory anyway.

As for your second point about paper losses being real, I think this is very subjective because none of us will get out at the very top in the long term, so as far as I understand you are stating that we all lose money when we sell.(potential profits).To me, while the trade is on, this would just be normal drawdown, when we close the trade, it goes back to risk/reward and basic profit or loss.No point thinking about what might have been, we would all drive ourselves crazy :screwy:

I still stand by my point about moving the stop to breakeven as soon as possible becomes a no risk trade.The more we can do this, the less losses we have (which isn't overly important) but we are giving ourselves the chance of only making profits in the long term.


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## It's Snake Pliskin (26 March 2006)

> I still stand by my point about moving the stop to breakeven as soon as possible becomes a no risk trade.The more we can do this, the fewer   losses we have (which isn't overly important) but we are giving ourselves the chance of only making profits in the long term.




Good words Porper!


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## It's Snake Pliskin (26 March 2006)

Bullmarket,



> Imo, what you are saying in the above extract is that if on Eddie's show a contestant gets the $1M question wrong and then drops back to $32k that he/she hasn't lost $468k when in fact they had the option to take the $500k.




A poor analogy of risk as we are talking about the markets here. It is quite possible to get that money back in the markets, as you would know being an investor.

Enjoy the time with the wife. :blover: 
Snake


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## It's Snake Pliskin (26 March 2006)

Porper said:
			
		

> Maybe I didn't explain well enough, but with regards to the stop losses being guaranteed, I was infact referring to CFD'S where the stop is 100% guaranteed.So if your stop was set at one dollar and overnight a profit warning is sent out to the market and it opens next day at 0.70c, you will still get out at one dollar.
> 
> With normal trading I am not sure whether you can trade with guaranteed stops, in new Zealand you certainly can't.




Macquarie calls them a guaranteed stop loss. Very impressive Macquarie I must say.


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## bullmarket (26 March 2006)

*Hi porper *

no problem, but I think you are taking the example I gave far too literally because of course I accept that no-one sells at the very top on every occasion.

The point I was making is that imo if you watch a share price fall back all the way to break even and then close out the trade when you had opportunities to close out at any time whilst still in profit then I see that paper loss as a 'real' loss as in the similar circumstances I described re Eddie's show.

As I said in my earlier post whether people see paper losses as real or not is up to each individual and so we'll just have to agree to disagree on the 'reality' of paper losses.

cheers 

*Hi Snake *

You have quoted me out of context and that extract was clearly not an analogy on my part of risk at all. 

The extract was clearly an example of how I see paper losses in reply to porper's view of paper losses....nothing more, nothing less 

Hopefully my above reply to porper  will clarify the purpose of my Eddie example for you but if you see it as meaning something else then so be it.

cheers

bullmarket


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## Porper (26 March 2006)

bullmarket said:
			
		

> *Hi porper *
> 
> no problem, but I think you are taking the example I gave far too literally because of course I accept that no-one sells at the very top on every occasion.
> 
> ...




Bullmarket, I am not saying set the stop at break even and to leave it there, that would be irresponsible to the extreme.What I am saying is once this is done, we are in a risk free trade, then it is up to us to manage the price action as we feel fit, whether that be a trailing stop, count back or whatever.

As for taking profits, well I don't consider myself an expert,I get it wrong as often as I get it right.If anybody says they consistently get out near the top, I would love to talk to them and find their method, or call them a wee fibber !!

Anyway, must go and peel the spuds and sprouts or Mrs Porper will peel me


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## Julia (26 March 2006)

bullmarket said:
			
		

> *Hi porper *
> 
> The point I was making is that imo if you watch a share price fall back all the way to break even and then close out the trade when you had opportunities to close out at any time whilst still in profit then I see that paper loss as a 'real' loss as in the similar circumstances I described re Eddie's show.




bullmarket:  That sounds simply silly to me.  If you applied that principle of paper loss as representing real loss then, unless you *have*  some pretty extraordinary talents (?)  you are going to feel frustrated a lot of the time.  If you were a trader, or even a n investor who buys and sells reasonably frequently (which we know you are not) how often do you think you would pick the top.? 

I understood Porper's entirely logical suggestion was simply a means of avoiding a loss by setting a breakeven point.  Really don't know why you couldn't just accept that.



			
				bullmarket said:
			
		

> As I said in my earlier post whether people see paper losses as real or not is up to each individual and so we'll just have to agree to disagree on the 'reality' of paper losses.
> 
> cheers
> 
> ...




Maybe I'm missing something here, but it didn't appear to me that Snake had quoted you out of context.

Julia


----------



## bullmarket (26 March 2006)

Hi Julia 

no problem - others have understood what I was saying in my Eddie analogy in relation to how I see paper losses 

So if you or Snake don't understand or agree with what I was saying then I don't have a problem with that simply because others have at least understood and whether they agree or not is entirely up to them.  I just gave my view on paper losses and a supporting example.

As someone else said in another thread recently - if we all agreed on everything all the time this would be a pretty boring place   

cheers

bullmarket


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## bullmarket (26 March 2006)

Hi porper



			
				Porper said:
			
		

> Bullmarket, I am not saying set the stop at break even and to leave it there, that would be irresponsible to the extreme.What I am saying is once this is done, we are in a risk free trade, then it is up to us to manage the price action as we feel fit, whether that be a trailing stop, count back or whatever.
> 
> As for taking profits, well I don't consider myself an expert,I get it wrong as often as I get it right.If anybody says they consistently get out near the top, I would love to talk to them and find their method, or call them a wee fibber !!
> 
> Anyway, must go and peel the spuds and sprouts or Mrs Porper will peel me




ok no problem I can see more clearly now what you are saying and fair enough 

and good luck with the spuds - I know exactly how you feel   

I'm getting away with spending time in here today because I'm also watching the Comm games on the portable out the back with mrs bullmarket and checking in here whenever I come inside to refill her glass   

cheers

bullmarket


----------



## It's Snake Pliskin (26 March 2006)

> So if you or Snake don't understand or agree with what I was saying then I don't have a problem with that simply because others have at least understood and whether they agree or not is entirely up to them. I just gave my view on paper losses and a supporting example.




Bullmarket,

I understand that you don`t know what you are on about.  :1zhelp: 
So what is a paper loss exactly? I don`t know.  :dunno:  Please validate your point that I have not understood, that`s if Mr Bullmarket lets you....ahh, sorry MRS B>


----------



## bullmarket (26 March 2006)

Hi snake 

I'm not convinced you are telling the truth when you say you don't know what a paper loss is 

have a pleasant evening and I'll see you in the swamp 

bullmarket


----------



## It's Snake Pliskin (26 March 2006)

bullmarket said:
			
		

> Hi snake
> 
> I'm not convinced you are telling the truth when you say you don't know what a paper loss is
> 
> ...




Bullmarket,

I`m saying I don`t, so please don`t avoid the question and please tell me what I don`t understand.


----------



## ducati916 (27 March 2006)

100% negative outcome = No Risk
100% positive outcome = No Risk

Therefore through "a priori" reasoning we can state;
*Risk = Uncertainity of a specific outcome.* 

Relevant to us, and our classification of RISK, we would fall under the further clarification of *speculative risk.* as opposed to say *pure risk.* 

Within speculative risk we participate within the financial markets.
The financial markets encompassing for this purpose, Stock markets, Futures markets, Options markets, Currency markets, Commodities markets, CFD's markets.

Generalising a little, the financial markets are composed of three types of analytical participants, Fundamentals, Quants, Technicals.
Each style of analysis utilizes very different methodologies in measuring *opportunity* 

Opportunity is then via analysis quantified into a hard number that represents potential risk, and a hard number that represents potential reward.

As a point of separation the analysis is performed on very different analytical data inputs. Fundamentals measure and quantify *Business risk.* Technicals measure and quantify *Market risk* 

The two sources of data provide potentially very different quantifications of Risk & Reward for the same security.

Market risk is measured by *Price* 
Therefore the studies as expounded via Fama et al. within *Efficient Market Theory* are the benchmark that adequately explain Market risk.

Business risk is measured via *Capitalization structure, Operational results, and Intangibles* and as a consequence pays no heed to *Market risk* 
Thus, cannot be included within *EMT* 
This has given rise to further theories that operate in tandem with EMT, and have simply been labeled *Inefficient Market Theory* the irony being that if both operate as postulated, that in *longer timeframes, you will achieve a true EMT* 

Intrestingly some common words keep cropping up that are used out of the correct context;

*Probability* 
Refers to the mathematical concept of *statistical significance* 
If you use "PROBABILITY" within your argument of RISK, you are really saying that you have *designed a statistical model for your theory, that conforms to rigourous statistical methodology, (which uses the Law of large numbers)* and that through the testing of this statistical model, you have achieved a result that *possesses STATISTICAL SIGNIFICANCE to a specified CONFIDENCE LEVEL* 

If you have not performed this work, you are incorrect in referring to the term *probability* you are in point of fact referring to a completely separate paradigm.

Which is a; *Deterministic model* 
This is a very different model for the assessment of RISK than a model utilizing a *probability based model* 

*Risk management methodologies* 
Again two separate concepts have seemingly intermingled;
*Stoplosses, and Diversification* 



> Going on a bit, often written puts are described as having unlimited risk. Therefore straight shares, must also have unlimited risk. (It's not actually unlimited because you can't go past zero, but it is unquantifyable)
> 
> This is why folks use stops. Put writers can also use stops.




This nonsense appeared on pg1.
This really demonstrates the confusion, misinformation, or plain lack of cognitive analysis performed.

Lets just break it down;



> Therefore straight shares, must also have unlimited risk. (It's not actually unlimited because you can't go past zero, but it is unquantifyable)




Common shares cannot go below zero.
Therefore your risk is quantifiable, it is a 100% loss of your capital.



> Going on a bit, often written puts are described as having unlimited risk.




This is dependant upon the *instrument that they are written against* if they are written against common stock as a "PUT", then they have a *limited loss* as once the common (the underlying) falls to zero, the loss is 100% and the losses within the derivative are also limited.

If you have written a derivative against a derivative, that is calculated on an underlying, for example a *Futures contract, derived from an underlying index (S&P500), then the loss will = 100% if and when the S&P500 index goes to zero* as then the Futures contract will lose no more value, and your exposure via the written PUT against the futures contract will also = 100%

Of course there is a second factor that limits (potentially only) loss, and that is the *expiry and exercise date* 

The Option that exposes you to theoretical *unlimited risk, is the Naked Written CALL* with a long in the future expiry.
This is true because, in theory we can not quantify risk in the same way.
The "Price" can go from $1 to $10, to $100, to $1000, to $100K per share and even further, therefore we can never write RISK = 100%



> This is why folks use stops. Put writers can also use stops.




Yes they can.
However this is not a "guaranteed" or hard stop equivilent to the product listed by Maquarie with CFD's. Therefore, your risk is only managed at your eventual exit point. So excluding the aforementioned example, stoplosses are a risk management tool, but are not definitive of your ultimate risk.

jog on
d998


----------



## wayneL (27 March 2006)

:band


----------



## stevo (27 March 2006)

> 100% negative outcome = No Risk
> 100% positive outcome = No Risk




Known outcome = No Risk

stevo


----------



## Bobby (27 March 2006)

wayneL said:
			
		

> :band



Love the band ! : .
How appropriate ~~~.

Bob.


----------



## tech/a (27 March 2006)

Ah Duc.

*Excellent some understanding of RISK*

You may have to use some examples which are easy for all to follow.
Stevo's put in some intesresting stuff as well.
Hopefully I'll have some time to get "involved" soon enough.


----------



## ducati916 (27 March 2006)

*stevo* 



> Known outcome = No Risk




Indeed.

*tech/a* 

Jump in whenever baby!

*Diversification* was adopted, or borrowed from the Insurance industry, from which it forms the underpinning of *underwriting risk* 
It was incorporated into the financial markets, as it had worked very successfully, over a long period of time, and a large number of individual cases, providing a statistically significant result, with a high confidence level to the results.

There are however some important differences.
If underwriting life insurance, the statistical body of evidence gathered over many years, added to medical statistics regarding mortality rates, due to age, accidents, disease, etc. provided Actuaries with hard data, that changes very little over time.

In the stock market, we have to utlize diversification within two separate classes of risk. *alpha risk, and beta risk* 
Which due to the competitive and secretive nature of the markets makes the aquisition of hard data quite challenging.

alpha risk, is the risk that is better described as *business risk* that will incorporate the following risks;
Peril,
Physical hazard
Moral hazard
Static risk
Dynamic risk,
Fundamental risks
Particular risks,
Speculative risk
Pure risk,
Liability risks
Failure risk,
Act of God.

beta risk, is Market risk, and most easily observed as "Price movement".
The beta assigned to individual stocks reflects their past volatility, as compared to the benchmark index, of which they are a member.

Both stoplosses, and diversification can be utilized in tandem, or individually, or of course, not at all. There are situations, according to the type of risk, or the amount (risk exposure) that one may be preferrable to the other.

jog on
d998


----------



## wayneL (27 March 2006)

> This nonsense appeared on pg1.
> This really demonstrates the confusion, misinformation, or plain lack of cognitive analysis performed.




non·sense   Audio pronunciation of "nonsense" ( P )  Pronunciation Key  (nnsns, -sns)
n.

   1. Words or signs having no intelligible meaning: a message that was nonsense until decoded.
   2. Subject matter, behavior, or language that is foolish or absurd.
   3. Extravagant foolishness or frivolity: a clown's exuberant nonsense.
   4. Matter of little or no importance or usefulness: a chatty letter full of gossip and nonsense.
   5. Insolent talk or behavior; impudence: wouldn't take any nonsense from the children.

Main Entry: con·fu·sion
Pronunciation: k&n-'fyÃ¼-zh&n
Function: noun
: disturbance of consciousness characterized by inability to engage in orderly thought or by lack of power to distinguish, choose, or act

misinformation

n : information that is incorrect

cog·ni·tive   Audio pronunciation of "cognitive" ( P )  Pronunciation Key  (kgn-tv)
adj.

   1. Of, characterized by, involving, or relating to cognition: “Thinking in terms of dualisms is common in our cognitive culture” (Key Reporter).
   2. Having a basis in or reducible to empirical factual knowledge.

cog·ni·tion   Audio pronunciation of "cognition" ( P )  Pronunciation Key  (kg-nshn)
n.

   1. The mental process of knowing, including aspects such as awareness, perception, reasoning, and judgment.
   2. That which comes to be known, as through perception, reasoning, or intuition; knowledge.

The above denunciation appears to revolve around my use of the the "unquantifiable"

Main Entry:  	unquantifiable
Part of Speech:  	adjective
Definition:  	unable to be counted or to have a value assigned; impossible to determine the quantity of

In the strictest sense, the maximum risk of a written put is quantifiable as far as ordinary shares are concerned, in that the same may indeed go to 0 and no further. With futures however, because of the nature of the underlying, this is unlikely to ever be the case. So maximum risk, in this case, is indeed unquantifiable.

However, I am comfortable discarding this term in favour of "indeterminable"

in·de·ter·min·a·ble   Audio pronunciation of "indeterminable" ( P )  Pronunciation Key  (nd-tÃ»rm-n-bl)
adj.

   1. Impossible to fix or measure: indeterminable traces of poison; indeterminable assets.
   2. Impossible to settle or decide with finality: indeterminable questions.

Athough the presense of 0 may ultimately quantify our maximum risk in a limited number of cases, it is impossible to determine the extremely unlikely probability of such an event ever occuring in those cases where it is possible.

Certainly the risk of a written put (naked that is) is NOT unlimited. It is questionable whether the risk is quantifiable or not; in some cases is is certainly not quantifiable. So indeterminable seems to be the best fit.

I now turn to the written, naked call. Most textbooks, and indeed certain members of this very forum refer to the risk as "unlimited". 

un·lim·it·ed   Audio pronunciation of "unlimited" ( P )  Pronunciation Key  (n-lm-td)
adj.

   1. Having no restrictions or controls: an unlimited travel ticket.
   2. Having or seeming to have no boundaries; infinite: an unlimited horizon.
   3. Without qualification or exception; absolute: unlimited self-confidence.

Again an arguable point. Unlimited infers the infinite, whereas the risk of a written call is eminently limited by the maximum price people are prepared to pay for the asset. And there will always be a maximum price. Since we are indulging in extreme pedancy, (if that is a word) we must abdicate this inaccurate term, in favour of either unquantifiable or indeterminable, both of which are accurate.

Refering back to the original statement which I quoted above, and an examination of language contained therein, I can only conclude were written for reasons other than for  accuracy of facts and reasoned debate. This is in contrast to the other excellent points in the rest of the post. However I will put it down to "hyperbole" an leave it at that.

hyperbole

n : extravagant exaggeration [syn: exaggeration]

Cheers


----------



## It's Snake Pliskin (27 March 2006)

tech/a said:
			
		

> Ah Duc.
> 
> *Excellent some understanding of RISK*
> 
> ...




No give us the hard ones!

All from the alchemy of finance too! :blaah:


----------



## It's Snake Pliskin (27 March 2006)

> 100% negative outcome = No Risk
> 100% positive outcome = No Risk




This is wrong! 

A negative result would cost you money. If so you have risked money!

A positive result would make you money. If so you have risked money to get that result!

Stevo put it right by saying "Known outcome = no risk". So if you know the outcome you wouldn`t be risking anything, as there would be a known outcome- something like 100% guaranteed.


----------



## tech/a (27 March 2006)

You are equating Risk with money.

In these instances Risk alone is equated.
You have 2 knowns each resulting in zero risk.

If you wish to relate that back to money then entering a trade with a known
risk of 100% loss would not be equated as taking any risk what so ever,youll have NO risk of making any profit yet 100% guarentee of making a loss.

The decision is then not risk based---more to do with stupidity I would argue.
(Nothing personal Snake!)

This is important as the discussion continues.


----------



## It's Snake Pliskin (27 March 2006)

> You are equating Risk with money.




Yes I am.



> In these instances Risk alone is equated.
> You have 2 knowns each resulting in zero risk.
> 
> If you wish to relate that back to money then entering a trade with a known risk of 100% loss would not be equated as taking any risk what so ever,youll have NO risk of making any profit yet 100% guarentee of making a loss.




But you would still lose money if you took it on, so it would be a guaranteed loss of money, more so than risk of money. The point I made about stevos comment. But in reality nothing is known especially in the markets, nothing is guarnateed! So, who would take on a 100% guarantee of loss? 

Is this thread guarantee or risk?

Sorry..(no offence tech)
It all seems pointless as in the markets we risk money - ultimately, unless something has changed and no one told me about it. So a discussion on that is what I thought the thread was for. If it is textbook definitions and regurgitation then I have extracted myself form the discussion. I get the gist of Wayne`s post to see how ridiculous it has become - not Wayne but the hyperbole! 

Have a nice day all.

Snake


----------



## tech/a (27 March 2006)

Patience Snake.

To discuss something with a broad and often un informed view of the topic will result in disjointed and irrelevant outcomes.
Your input is great and so is "most" others which raise question and define points of veiw in specific terms.

All will slowly come together into something useful---well more than useful--damned necessary.


----------



## It's Snake Pliskin (27 March 2006)

Lets see where it goes then.....  As for me I`m off for coffee.


----------



## ducati916 (27 March 2006)

*Snake* 

I see that *tech/a* has already corrected your misunderstanding of my previous post with regard to a definition of risk. 



> It all seems pointless as in the markets we risk money - ultimately, unless something has changed and no one told me about it. So a discussion on that is what I thought the thread was for. If it is textbook definitions and regurgitation then I have extracted myself form the discussion. I get the gist of Wayne`s post to see how ridiculous it has become - not Wayne but the hyperbole!




Interesting point of view.
I suppose you would rather then be subjected to inaccurate opinion, rather than accurate and commonly accepted finance theory?
Of course, if you have a problem with commonly accepted finance theory, and I very often do myself, then by all means highlight the offending theory, and offer your refutation, based on whatever argument that you feel is pertinent.



> All from the alchemy of finance too!




This unfortunately, is just nonsense.
As by way of evidence for refutation of said nonsense, see the following link;

http://lightning.he.net/cgi-bin/suid/~reefcap/ultimatebb.cgi?ubb=get_topic;f=25;t=000140

jog on
d998


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## bullmarket (27 March 2006)

I think everyone in here understands the overall concept and definition of risk and  imo stevo summed things up very well in his earlier post where he clearly defined risk and pointed out a half dozen or so subsequent relevant points. I agree 100% with stevo's points as they are essentially the premise I used for coming up with the way I manage my risk in my fundamental and technical analysis.  After stevo's post I haven't seen any post that wasn't essentially covered already by him. 

For anyone interested in doing some research on risk analysis there is an absolute plethora of info on the www.  I googled 'calculate portfolio risk' and it came back with a truck load of sites.  

Calculating risk is by no means a trvial task and so can require extensive number crunching which the average trader would not even consider doing - _and I suppose that is why no-one has posted any algorithms for actually calculating risk for a particular scenario _ 

But for anyone interested in an overview of risk management maybe have a look at this site which is just 1 of thousnds returned from google.

From what I see, imo this thread is now slowly starting to go round in circles and spiral inwards to the point where everyone will soon be staring at their own navels and wondering what the hell they are looking at   

I think I'll research info on 'risk' from hereon on the www where for me personally it will be more relevant and meaningful.

cheers

bullmarket


----------



## tech/a (27 March 2006)

> I think I'll research info on 'risk' from hereon on the www where for me personally it will be more relevant and meaningful.




Excellent.
We will all speak amongst ourselves then without further input from you.

Navel gazing should be treated in a seperate thread.
You may wish to host it.

Enjoy your research.


----------



## bullmarket (27 March 2006)

no problem tech/a 

At least you can't blame me for this thread starting to go round in circles as I haven't posted anything more on how I handle risk since very early in the thread - and only touched on a side topic, paper losses, recently

All I did in my previous thread was give my reasons for where I see this thread heading and highlight to those interested that there is much better quality info on risk management on the www than what is being currently discussed in here 

If you want to be taken seriously you'll have to prove anything I said is wrong in my previous thread and then start posting some algorithms and examples for actually calculating risk - otherwise, as I said, everyone will be staring at their own navels in this thread soon wondering what the hell they are looking at and what it all means   

Good luck in your discussions but there hasn't been anything significantly new posted since stevo's first post and so it appears you're running out of steam.

cheers

bullmarket


----------



## Bobby (27 March 2006)

tech/a said:
			
		

> Excellent.
> We will all speak amongst ourselves then without further input from you.
> 
> Navel gazing should be treated in a seperate thread.
> ...





But Tech ,

 Maybe bulls in training for the next Comm games in the new yet to be announced  sport of - Most posts per session !  

Bob.


----------



## tech/a (27 March 2006)

Each to their own.


You seem to be upset with my post challenging your understanding of risk.
Thats fine.
I will post what I like when I like.
Your welcome to re join the discussion with any new practical information you gleen in your studies.

To suggest that your postings (and that of Stevo's) are definative and full discussion of Risk and its use in trading is stange to say the least.


I certaintly encourage anyone seriously interested in possibly the most important aspect of Financial Independance-----*Risk* to search the web---however do not limit your education to "Portfolio Risk".
It can only add to the discussion.

Thank you anyway for your input and do enjoy your evening.

Goodluck in your endeavours.


(Ive grown out of smilies)


----------



## bullmarket (27 March 2006)

no problem tech/a 

they say imitation is the highest form of flattery, so thank you 

see you in the swamp 

bullmarket


----------



## ducati916 (27 March 2006)

*bullmarket* 

I assume this is the post that you were referring to.



> I mitigate investment risk through diversification and fundamental analysis (as I described in other threads).






> Nowadays I invest with income as my number 1 priority and with my current risk profile I am invested only in LPT's and energy/infrastructure trusts for their high yields.




You claim diversification, yet are utilising only two sectors, energy/infrastructure trusts & Listed Property Trusts.
Two sectors could be argued as being far from diversified, and in contradistinction actually concentrated.



> I'm now starting to also look at trusts that invest in the European property market for extra diversification and spread of risk.




But, again, you are not diversified out of the same two sectors. Different continents..........brings up an interesting component of risk, and this is the *Concept of CORRELATION* 

Financial markets have become increasingly correlated under specific conditions, for an example look no further back than 1998, and Long Term Capital Management.

Correlation, and *fat tails* go hand in hand, and are an essential component of risk, and risk management.

Correlation is a statistical term, and again is calculated via a statistical significance, usually to two standard deviations, and a concurrent confidence interval.

Fat tails are of course outlier events that exceed two, three, four standard deviations, and should statistically only occur once every million years or so.
Unfortunately, they seem to crop up every couple of years or so.

A robust risk management model must, or it would be eminently sensible to at least entertain the thought of incorporating outliers into your risk model, and generating a strategy that would attempt to minimise the damage, if diversification, suddenly correlated *to 1* 

jog on
d998


----------



## bullmarket (27 March 2006)

Hi ducati 

I agree in principle with what you say but now you are starting to talk about the *extent * of diversification within a portfolio to minimise risk.

*Let me refer you to my signature below each post. It clearly states that views I post are suitable for my personal circumstances and so may or may not be suitable for other people.*

For me personally, being an income investor, being solely invested in those two sectors makes it easy for me to achieve my investment objectives and still be well within my personal risk profile.  

I am diversifying within those two sectors and not beyond atm and am happy with the returns I am getting and I am very comfortable with the level of risk I am carrying at the moment.

And all of the above obviously by no means suggest others should blindly copy what I am doing.  It works well for me and obviously may or may not work for others depending on their objectives and risk profiles.

cheers

bullmarket


----------



## tech/a (27 March 2006)

> I agree in principle with what you say but now you are starting to talk about the extent of diversification within a portfolio to minimise risk.




Actually he is touching on correct use of diversification.

Subtle really you may have missed it.

Enjoy your evening.


----------



## happytrader (27 March 2006)

Interesting thread.

Lets say you know all the possible risks involved in trading a particular security because you've seen this whole setup many, many times before. In fact it follows through 9 times out of 10 very high probability. You have an exit strategy which is also high probability and know you'll be wrong when your 10% loss is breeched. Theres plenty of open interest so you can get out quickly. 

So what possible reasons would there be for you not to take that trade.
That would depend on what you are saying to yourself and the feelings you  are invoking by doing so. 

Are you defining yourself by your past by way of your last losing trade? Are you telling yourself you don't deserve this? Are you telling yourself you are just not worth the risk? Are you punishing yourself? (almost forgot this one).Whatever, you are saying and however, you are saying it, its probably not in line with what the market is presenting you with now. Drag up that feeling, acknowledge it and manage it.

As a trader your mind must be in the present. For a trader the real risk is not knowing and accepting who you are. This is emotional intelligence.

Cheers
Happytrader


----------



## bullmarket (27 March 2006)

no problem tech/a 

as I said, I am happy with the *extent* of my diversification, the level of risk I am carrying and the returns/income it is generating and so it must be 'correct' for my personal circumstances as you put it  (ref: my signature below)

As long as mrs bullmarket sees those quartely/half yearly distributions coming in she's happy and if she's happy then I am happy   and I am fairly confident that in say 5-10 years time the investments I currently hold will be worth more overall than they are now everything else being equal - by how much,? time will tell but capital gains is not my #1 priority nowadays, income is 

cheers

bullmarket


----------



## tech/a (27 March 2006)

Lets look at this probability treatment of RISK.

What seems to being stated is that one needs to define the probability of risk to mitigate it.
What is happening is there is a new subjective component being added--Probability.Unless you know 100% win or Lose the probability will be subjective.Assigning probability can be statistically relevant but generally not.

Taking B/M's example of allocating a point score for his Fundamental Analysis of a stock is simply ranking.Risk remains the uncertainty,albeit mitigated *in B/Ms veiw* certaintly not in mine--he has made it vitally clear that it works for him.

Take this exercise on Risk and Probability.
I argue that probability is information based,and even with the best information doesnt solve the problem of risk entirely,there are pieces which if left out of the evaluation process could result in ruin.---slower maybe/maybe not.

I have a covered jar of M&Ms I tell 2 people that there are green and yellow M&Ms in the jar.
Person one knows only this--person 2 I tell that there are 3 green M&Ms to One Yellow M&M.

I ask each to pull out a green M&M.
Does person 1 have greater risk than person 2 of being incorrect.
Does being armed with knowledge of greater probability of success infact place 2 in a better position to selecting a correctly coloured M&M?

What more do we need?


----------



## ice (27 March 2006)

What if you don't like M&M's?


ice


----------



## RichKid (27 March 2006)

tech/a said:
			
		

> Lets look at this probability treatment of RISK.
> 
> What seems to being stated is that one needs to define the probability of risk to mitigate it.
> What is happening is there is a new subjective component being added--Probability.Unless you know 100% win or Lose the probability will be subjective.Assigning probability can be statistically relevant but generally not.
> ...




Nice example Tech about working out the probability of an outcome. I'm still learning about these things but don't really need to know the esoteric aspects.  I haven't been following this thread too closely so I don't know how apt an analogy your example is but it helps to illustrate the subjective biases in probability problems (to me anyway). Like lotto bias where you think you can improve your odds by consulting a numerologist or by choosing the numbers yourself instead of having a machine do it. One of the problems with stocks is that there is so much info and so many figures and theories out there that it gets confusing.


----------



## lesm (27 March 2006)

Watching this topic with interest, as it is an important one are for people to understand.

If you were to ask a lot of people what they consider the risks to be in pariticpating in the financila markets it would be interesting to listen to their respones. It is not unusal to find that when people discuss risk management in a range of areas that they really do not understand what the real risks are.

A number of the popular texts put forward strategies, such as diversification while failing to ensure that the intended audience really understand the associated risks. Similarly with respect to approaches, such as arbitrage, which again is a subject in its own right. Many arbitrage examples are used where they show zero risk examples, but fail to also cover the situations where this is not always true or situations, which may arise that change the risk profile. This a subject area that is beyond the current topic, buut important for peolpe to fully understand arbitrage and the associated risks.

Oversimplication is dangerous and misleading

Anyway, I hope people find the extracts below of interest.

Cheers

The following extracts and additional information can located via the URL below:
http://www.riskglossary.com/link/risk_management.htm

"*Risk * has two components:
uncertainty, and 
exposure.

If either is not present, there is no risk.

Suppose a man jumps out of an airplane with a parachute on his back. He may be uncertain as to whether or not the chute will open. He is taking risk because he is exposed to that uncertainty. If the chute fails to open, he will suffer personally.

Now suppose the man jumps out of the plane without a parachute on his back. If he is certain to die, he faces no risk. Risk requires exposure and uncertainty.

*Hedging and Diversification*

A portfolio that is invested in multiple instruments whose returns are uncorrelated will have an expected simple return which is the weighted average of the individual instruments' returns. Its volatility will be less than the weighted average of the individual instruments' volatilities. This is diversification. Diversification is the "free lunch" of finance. It means that an investor can reduce market risk simply by investing in many unrelated instruments. The risk reduction is "free" because expected returns are not affected. The concept is often explained with the age-old saying "don't put all your eggs in one basket."

Diversification should not be confused with hedging, which is the taking of offsetting risks. With diversification, risks are uncorrelated. With hedging, they have negative correlations.

A common misperception is the notion that the more uncorrelated risks a portfolio is exposed to, the lower that portfolio's overall market risk will be.

This is not true. If a portfolio is leveraged in order to take new risks, the net result is likely to be an increase in risk.

Let's consider a common example:

A salesman for a foreign exchange trading firm approaches the trustees of a pension plan and proposes that they add a currency overlay strategy to their existing portfolio of domestic stocks and bonds. The strategy will consist of an actively traded portfolio of currency forwards. Because forwards represent long/short positions, they require little or no up-front investment.

Accordingly, the strategy could be implemented without changing any of the plan's existing investments. That is why it is called an "overlay" strategy. 
In addition to possibly generating positive returns, the salesman argues that the added exposure to currencies will have a diversifying effect on their portfolio””decreasing the portfolio's total market risk.

Is the salesman right? Will the overlay strategy reduce the portfolio's market risk? At first blush, it is difficult to say. Fluctuations in the value of the overlay portfolio should have little or no correlation with returns on the existing portfolio. On the other hand, the overlay strategy introduces a new risk in addition to the portfolio's existing risks.

In fact, the salesman is wrong. Far from reducing market risk, the overlay strategy will increase total market risk. The overlay strategy does diversify the portfolio's risks, but it also leverages them. The diversification effect will reduce market risk, but this will be more than offset by the leveraging effect. 
Let's look at the situation in terms of eggs and baskets. Suppose you are carrying a basket of 12 eggs. To diversify your risk, you might obtain a second basket and place six of the eggs in it. Now, carrying one basket in each hand, you will have reduced risk. Suppose instead, you act under a misperception that risk is reduced by simply carrying more baskets of eggs. Instead of dividing your 12 eggs between two baskets, you instead offer to carry your friends basket of 12 egg as well as your own. Now you are carrying two baskets of 12 eggs each. In financial terminology, you have leveraged your position. The net result is an increase in risk. In effect, this is what the salesman's overlay strategy will do to the pension portfolio.
For diversification to work, it is not sufficient to add risks to a portfolio. Instead, where there are concentrations of risk, these need to be reduced while other, unrelated risks are taken on.

The issue of how investors can use diversification to optimize their portfolios is a central concern of portfolio theory"


----------



## bullmarket (27 March 2006)

I use a dictionary definition of risk: (which is what stevo also used from memory)

Risk = Probability of an event occuring

Now that 'event' could be anything you like....ie....a share price continuing in the direction one currently interprets it to be heading.  

*So in a simplistic case*, if you find from your paper trading or whatever simulation technique you use, that given your predetermined entry signals being met (from chart patterns, indicators or whatever) the share price continues to rise on at least the next day 75 times out of a hundred then your entry criteria being met on any single occasion will have a 75% probability of giving a profitable trade for the next day in the future.  So in this simplistic example the risk of successful trade is 75% and the risk of a failed trade is 25% imo.

I agree with you that assigning probability is information based but then so will everyone else who studied calculating probability in Applied Mathematics back in Forms 5 & 6 in high school. (which is a very long time ago for me now   )

eg......even in the case of tossing a coin with 2 possible outcomes you might find that if the coin is unevenly weighted that heads might come up say 600 times out of 1000 and so for that coin the probability of head on a single toss would be 60%.  But had the frequency of the possible outcomes for the coin been evenly distributed then obviously the probability of a head would be 50%

And scratching my head trying to remember all this stuff, I recall there are different types of distributions that occur in nature for different types of events....ie.....normal, binomial, poisson and hypergeometric distributions are some I can remember - there may be more for all I know atm

The probability of a single event occuring in nature, investing or whatever will be determined by which of the above distributions you apply to the frequency of all the possible outcomes.

So this is where I imagine calculating 'investment/trading' risks becomes hairy and involves some serious number crunching and there is plenty of info on this on the www as I mentioned in an earlier post. 

So unless you have software with sufficient grunt to calculate these risks for you under different scenarios/environments the vast majority of traders are left with paper trading and documenting the results until the distribution of the possible outcomes is determined in order to then asses the probability of the trading plan succeeding in the long run.  Obviously the more data you get from paper trading the more accurate will be the plan's probability of success - but then you can't paper trade forever either 

hope this helps

bullmarket 

ps....I doubt I will be around tomorrow, so I'll pop in later this week if anyone wants to discuss further......have a good evening


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## tech/a (27 March 2006)

> So in a simplistic case, if you find from your paper trading or whatever simulation technique you use, that given your predetermined entry signals being met (from chart patterns, indicators or whatever) the share price continues to rise on at least the next day 75 times out of a hundred then your entry criteria being met on any single occasion will have a 75% probability of giving a profitable trade for the next day in the future. So in this simplistic example the risk of successful trade is 75% and the risk of a failed trade is 25% imo.




*And here lies the common error.
The risk for the next trade is not quantified it has not been determined.
The probability is 50/50 of the next day rising.
However the probability is 75 out of a hundered over the next 100 
trades,*which in itself is dependant on enough meaningful testing to return a statistically significant result. (Duc,your and my determination of statistically significant will always be poles apart---as I must accept an accuracy to prove arguement and you in turn must argue insignificance due to limited data).

Now repeat after me.
Risk is not to be confused with probability---Risk is not to be confused with probability.---you get the picture.



> So unless you have software with sufficient grunt to calculate these risks




No still cant grasp it.
Risk is not to be confused with probability---Risk is not to be confused with probability.---you get the picture---this time.


----------



## It's Snake Pliskin (27 March 2006)

Bullmarket,



> ps....I doubt I will be around tomorrow, so I'll pop in later this week if anyone wants to discuss further......have a good evening





Perhaps you can think of an answer to my question while you are at it. Or, maybe Mrs Bullmarket could come on and give it to me....Now what is the probability of this happening? 

Smilie on Bullmaster


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## bullmarket (27 March 2006)

Hi snake 

the probability is now zero  because I have already replied to your question asking what a paper loss was and you even quoted my reply in a subsequent post....so I'm not sure let alone care what you are playing at because as I mentioned earlier,  if you do not understand what I was saying in my Eddie analogy then that is totally fine by me. 

_and given that no-one else has rushed in to explain to you what a paper loss is suggests to me that others, just like me, are also not convinced that you were telling the truth when you stated that you did not know what a paper loss was. _

but if you really need to know, then maybe start a new thread asking people what a paper loss is and if someone genuinely believes you do not already know the answer then hopefully they will help you out.

good luck 

bullmarket


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## It's Snake Pliskin (27 March 2006)

Duc baby,



> I see that *tech/a* has already corrected your misunderstanding of my previous post with regard to a definition of risk.




Oh, has he?



> Interesting point of view.
> I suppose you would rather then be subjected to inaccurate opinion, rather than accurate and commonly accepted finance theory?
> Of course, if you have a problem with commonly accepted finance theory, and I very often do myself, then by all means highlight the offending theory, and offer your refutation, based on whatever argument that you feel is pertinent.




Well, I`m afraid there is nothing I can do about Bullmaster. From someone suitably qualified, I would love to here it as it applies to the markets. Nothing has offended me.



> This unfortunately, is just nonsense.
> As by way of evidence for refutation of said nonsense, see the following link;
> 
> http://lightning.he.net/cgi-bin/suid/~reefcap/ultimatebb.cgi?ubb=get_topic;f=25;t=000140




Sorry.

Rock on baby!
Snake


----------



## It's Snake Pliskin (27 March 2006)

Bullmaster baby,

There is nothing sinister just waiting for an answer, clarification....



> but if you really need to know, then maybe start a new thread asking people what a paper loss is and if someone genuinely believes you do not already know the answer then hopefully they will help you out.




.......more how it applied to this thread and exact reasoning on it. So if you are not up to it I`ll have to go searching.

Wow that was quick I found something: 


> So unless you have software with sufficient grunt to calculate these risks for you under different scenarios/environments the vast majority of traders are left with paper trading and documenting the results until the distribution of the possible outcomes is determined in order to then asses the probability of the trading plan succeeding in the long run. Obviously the more data you get from paper trading the more accurate will be the plan's probability of success - but then you can't paper trade forever either




Probability you are talking about here, maybe odds, but not risk. But just not to take you out of context I`ll dig further.


----------



## bullmarket (27 March 2006)

hi tech/a 

we'll just have to agree to disagree on this one.

to be consistent then you would also say in my example of the weighted coin coming up heads 600 times out of 1000 that there is still a 50% probability of it coming up heads on any one toss when mathematically that is incorrect and the correct answer is clearly a 60% probability of a head coming up on any one spin.

imo the same applies to the entry signal example I gave and so if you want to believe it's still 50% then that's fine  and we'll just have to disagree 

cheers

bullmarket


----------



## bullmarket (27 March 2006)

good luck in your search then snake 

bullmarket


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## It's Snake Pliskin (27 March 2006)

Yup,

Probability!



> So in a simplistic case, if you find from your paper trading or whatever simulation technique you use, that given your predetermined entry signals being met (from chart patterns, indicators or whatever) the share price continues to rise on at least the next day 75 times out of a hundred then your entry criteria being met on any single occasion will have a 75% probability of giving a profitable trade for the next day in the future. So in this simplistic example the risk of successful trade is 75% and the risk of a failed trade is 25% imo.




So I can determine from your answer to me that was not addressed to me that you were talking about a totally different topic of probability and paper losses.


----------



## bullmarket (27 March 2006)

oh dear snake   

my post you extracted that quote from was directed at anyone who wants to read it and not specifically at you and was generally in reply to tech/a's M&M's post and had nothing to do with you whatsoever  

keep trying though - at least you're entertaining, for me at least 

cheers

bullmarket


----------



## bullmarket (27 March 2006)

anyway, I better go for now - I'll pop back in later this week

good night all


----------



## tech/a (27 March 2006)

> to be consistent then you would also say in my example of the weighted coin coming up heads 600 times out of 1000 that there is still a 50% probability of it coming up heads on any one toss when mathematically that is incorrect and the correct answer is clearly a 60% probability of a head coming up on any one spin.




Hmm would hate to be seen as lacking consistency.

So according to you then I would have a 40% chance of flipping a tail.

*So out of 2 possible outcomes(Any one toss as you say) all of a sudden I have a 40% chance of a tail and a 60% chance of a head.*

Hahahahaha

Logic also is not one of your strong points!

You've now progressed from annoying to amusing!!
Quicker than I thought possible.


----------



## It's Snake Pliskin (27 March 2006)

bullmarket said:
			
		

> oh dear snake
> 
> my post you extracted that quote from was directed at anyone who wants to read it and not specifically at you and was generally in reply to tech/a's M&M's post and had nothing to do with you whatsoever
> 
> ...




Well that makes me feel good baby!



> anyway, I better go for now - I'll pop back in later this week



Ok you do that. When you come back please elaborate on this:


> Calculating risk is by no means a trvial task and so can require extensive number crunching which the average trader  would not even consider doing - and I suppose that is why no-one has posted any algorithms for actually calculating risk for a particular scenario



...being your comment, and an investor I am drawing your attention to the words in red.

Snake


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## lesm (27 March 2006)

*Risk * (n) - exposure to the chance of injury or loss; a hazard or dangerous chance; _to run risks_, "_The Macquarie Concise Dictionary_"

*Risk*
the chance of something happening that will have an impact upon
objectives. It is measured in terms of consequences and likelihood. "_Australian Standard - AS/NZS 4360:2004 Risk Management_"

Scope of applicability of the standard includes Foreign Exchange and Investments.


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## bullmarket (27 March 2006)

tech/a 

try thinking of it this way and it might become clearer - the weighted coin example is similar to a 'loaded' dice.

now in a fair dice all six numbers will have a 1/6 probability of coming up on any one throw, but in a 'loaded' dice at least one of the 6 possible outcomes will have a higher probability of coming up on any one throw....it's as simple as that 

good night 

bullmarket


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## Bobby (27 March 2006)

bullmarket said:
			
		

> tech/a
> 
> try thinking of it this way and it might become clearer - the weighted coin example is similar to a 'loaded' dice.
> 
> ...




Well bull??.

Can you clear this up for us.  

Coin tossing, that is a fair set of coins =equal, Do you agree that probability theory is concerned with the mathematical analysis of quantities derived from observations of phenomena whose occurrence involves a chance element ?.
What do you think bull of this so far ?. 

For a mathematical theory the essential ingredients are that an act or experiment is performed (e.g. coin tossing ) all possible outcomes of which can at least in principle be specified & are observable ( heads or tails ) & that a rule is given whereby for each possible outcome or set of outcomes there can be defined in a consistent way  called the probability of the outcome or set of outcomes in question .

Yes or no bull ?

Have Fun Bob.


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## jurn (28 March 2006)

hello,

I've only started buying shares this year so I haven't looked much into risk.
but for me its the shape of your normal distribution bell curve thing at a point of time in the future.

I decided to look into things 1 year from now.
cash in my ING direct account around 5.5%. so my bell curve for this one is really a spike at 5.5%
I decided the blue chip shares I bought would return about 10%, based on past performance.
and some of the smaller ones I bought might return higher, but would be 'riskier', so their bell curve moved to around 20% but are much flatter and have a larger portion to the left side of the peak.
then I've mentally "multiplied" these together based on the proportion of my portfolio to each of these to generate my overall bell curve.
 

all fun.
Jurn


----------



## sails (28 March 2006)

tech/a said:
			
		

> .... Risk is not to be confused with probability---Risk is not to be confused with probability.---you get the picture. ...



I have generally thought that risk and probability have some bearing on each other - but it is an interesting concept Tech is trying to get across.  Not easy going though as this thread seems to have gone off on a tangent discussing probability     Perhaps the probability discussions need their own thread and let Tech get on with the subject of risk?


----------



## It's Snake Pliskin (28 March 2006)

Bullmarket,

I wrote:



> The correlation of holdings, positions should be known to understand the risk being carried. If your positions are highly correlated then you are taking on too much risk. All positions behave alike increasing your drawdowns for example.




You responded:



> In my personal case I am starting to look at property trusts that invest in the European commercial, industrial, retail and leisure property markets because from what I am seeing the prospective yields are about the same as trusts I am invested in that invest in US property atm and a little higher than what the LPT's in Australia are averaging atm.
> 
> Also, since my number 1 priority is income nowadays I personally don't mind if one goes up a bit while another goes down. Obviously I'd like all my investments to be going up at the same time all the time but that is just not going to happen and I certainly don't want to be spending hours on end doing research and analysis trying to find which sector/region etc is most likely to fire and risk getting it wrong. Mrs bullmarket already thinks I spend too much time on the pc as it is
> 
> I (and more importantly mrs bullmarket  ) are happy with the returns/income we are getting as they are meeting our objectives and I am reasonably confident that in say 5-10 years time the LPT's I am invested in will be higher in value, everything else being equal - how much? only time will tell but it's not my first priority.




Nothing added to the discussion, initially.

Duc then wrote:




> But, again, you are not diversified out of the same two sectors. Different continents..........brings up an interesting component of risk, and this is the Concept of CORRELATION
> 
> Financial markets have become increasingly correlated under specific conditions, for an example look no further back than 1998, and Long Term Capital Management.
> 
> ...




You responded:



> I agree in principle with what you say but now you are starting to talk about the extent of diversification within a portfolio to minimise risk.
> 
> Let me refer you to my signature below each post. It clearly states that views I post are suitable for my personal circumstances and so may or may not be suitable for other people.
> 
> ...




Again nothing added to the discussion and you have ignored the important issue of correlation with regard to diversification.


----------



## It's Snake Pliskin (28 March 2006)

> "*Risk * has two components:
> uncertainty, and
> exposure.
> 
> ...




Good point above.




> A common misperception is the notion that the more uncorrelated risks a portfolio is exposed to, the lower that portfolio's overall market risk will be.




Sure there is non-diversifiable or relevant risk to contend with regardless of the diversification.

How does one hedge a portfolio other than to invest/trade in the currency of the market in question?


----------



## happytrader (28 March 2006)

Hi Tech

Please correct me if I am wrong, but are we talking about managing the 'putting your money where your mouth is type risk? That is managing the the uncertainty and fear of a possible loss?

That the only time I see eyes glaze over and listen to people back peddling even after they've strongly defended their view. The analysis paralysis types.

Cheers
Happytrader


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## ducati916 (28 March 2006)

The general topic is starting to fragment slightly, which really is as it should be, as the definition of risk is only the starting point to try and get everyone on the same page, and barring some exceptions, most are in broad agreement as to the *definition of risk* 

We can now address some of the other related topic areas;

*Quantifying Risk models* 
Statistical models (probability, correlation, fat tails & standard deviation)
Non-statistical models (determinism)

*Analysis models* 
Fundamental analysis
Technical analysis
Quantitative analysis
Macro-analysis (economic/political)
Micro-analysis (economic/political)

*Risk management models* 
Stoplosses
Hedging
Diversification
Against the box
Options strategies
Dollar cost averaging
Buy & Hold
VAR
Efficient Frontier

So plenty to be getting on with regarding discussion.
jog on
d998


----------



## ducati916 (28 March 2006)

I suppose we could introduce these concepts now as well, as I see they have already been touched on by *happytrader, and I think lesm* and they are;

*Components of risk* 
Marketability
Liquidity
Leverage
Information flow
Slippage
Trading costs
Taxes

*Systemic risk* 
Exchange risk
Inflation risk
Interest rate risk
Political risk
Information flow

*Non-systemic risk* 
Psychological risk

jog on
d998


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## ducati916 (28 March 2006)

Just to add some further components to;

*Non-systemic risk* 
Psychological risk
Regulatory risk
Random event risk (labour disputes, legal actions, etc.)

jog on
d998


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## tech/a (28 March 2006)

happy.


> Please correct me if I am wrong, but are we talking about managing the 'putting your money where your mouth is type risk? That is managing the the uncertainty and fear of a possible loss?




Yes thats the idea I have in mind,it is however necessary to as Duc says get on the same page.

While I dont mind discussion on all or any of Duc's points It could well fragment the main purpose of what I originally had in mind being.

*The application of Risk and its Management in trading models.*

I will then try to place a practical bent on my posts on the topic refering where appropriate back to a trading example so that we can get a clearer picture of Risk and its Management in our day to day trading.

So on Risk and Probability.
When initially taking a trade we have an uncertainty (Risk) and an unknown probability of success or failure (Probability)

So it makes sence to Quantify that risk.


----------



## ducati916 (28 March 2006)

*tech/a* 



> While I dont mind discussion on all or any of Duc's points It could well fragment the main purpose of what I originally had in mind being.




I don't think that it will.
You can see from the multiplicity of opinions, that just the simple definition of risk had some rather disparate views.

If we (as a collective forum) build the model in a logical progression, then whatever model is eventually selected by individuals, they can have a transparent progression, and follow the logic of the construction process.

Teaching how to fish, as opposed to tossing out free fish.
Therefore under the variety of sub-headings we have the different elements that should at least be considered, as will be discovered, not all risk management methodologies can be employed, nor all risk negated.

jog on
d998


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## tech/a (28 March 2006)

Duc.

Not everyone is analytical as you are. I'm not and I dont think you need to be.Infact my view is being overly so can affect your trading.Analysis paralysis.But thats what makes exchanges interesting.

The problem then becomes one of Relevance,here we differ to you everything has relevance and is necessary,to me some is and not all is necessary.

As an example most traders believe that you just have to be right.
Using all sorts of analysis to be as certain as they can that when they put their $$s down that it WILL be a right decision.
Fundamentalists look at all sorts of ratios,pulling apart balance sheets looking for a "Warren Buffet" bargain.
All sorts of scoring tabulation has been designed,newsletters written,weighted expert opinion,you name it its been done all in the false belief that to make $$s you must be correct more often that your incorrect.
Tech analysts put so much rubbish on a chart you have trouble finding the price action.They cross reference oscillators,and draw a zillion lines all looking for confirmation in their analysis.

*The good news is that you DONT HAVE TO BE RIGHT MORE OFTEN THAN YOUR WRONG*

I found I was far better at getting things wrong than I was at getting them right.
Probability theorists have a burning desire to be right.They cant conceive that you can be wrong--dead wrong and STILL make great $$s.
Its a lot less stressful as well.

Anyway I will continue along a defined path of my discussion of RISK with the desire to keep it relevant to trading.
I'm sure Duc and I will get involved in disagreements,and I will become involved in some of Duc's discussions.
But for those concerned about falling in a never ending discussion representing Quicksand,I'll do my best to keep it relevant.

Finally.This is the way I treat risk.
I have found that after 12 yrs this is the way I like to trade.Its profitable as those that follow T/T can attest to.Its easy,no guess work,takes little time and is fun.
Its not sexy and its boring.
I'm finding it difficult to get the time to reply due to Workplace agreement changes that I have to attend to.Apologies.


----------



## ducati916 (28 March 2006)

*tech/a* 

That's ok you jog along, and I'll jog alongside, assuming that as a fat b*****d that I can keep up of course.

Obviously you are going to reference TT as the end product of the process.
I shall while you are hard at work sip my coffee and breakdown TT into nice little compartments for those that might be interested in the logic of the exercise.

*Analytical model utilized* 
I think we can agree that TT is *predominantly* a *technical analysis model* .........I say predominantly technical analysis, as there may be a component of Quant. within the design that I am not privy to.

*Quantification of risk model* 
Here we will disagree.
I have made my argument on a previous thread that TT is in point of fact a *deterministic model* while I suspect *tech/a & stevo would argue a statistical model* 
Irrespective of the actual model, an awareness of the risk inherent within the models should be a prerequiste.

*Risk management model* 
Stoplosses
Specific diversification 
VAR

*Components of risk assumed* 
Leverage
Liquidity
Marketability
Slippage
Trading costs
Taxes

*Systemic Risk* 
Ignored.

*Non-systemic risk* 
Psychological risk addressed
Open to random event risk

Just to expand on two components of risk management; stoplosses, and diversification.

Stoplosses fulfill our definition of risk, as the outcome is known and not *uncertain* Viz. stoplosses = 100% loss. (not 100% loss of funds).

Diversification;
Unfortunately, the model of diversification offered as an example, was proposed by a fundie (oh dear) but demonstrates a very poor understanding of the *risk* inherent in a poor diversification strategy.

Diversification, can be many things, one of them should include diversification of asset classes, Common stocks, Bonds, Commodities, Esoteric, Real Estate etc. Within the example we have as a major holding LPT's. Now assuming that you are exposed to real estate via the ownership of the family home, or investment properties, you could have correlated across asset classes. Commercial property can under again specific conditions correlate either strongly or weakly with residential property. Have these inherent risks been addressed?
Investment properties can be either residential or commercial, thus will be variable within their correlations to other positions......but you get the idea.

Is this a wise use of diversification? Time will tell.
Is this the purpose (in theory) of diversification? Simple answer no. The reason being, you are not diversifying at all, rather, you are concentrating.

I believe someone mentioned Buffett as an example of a concentrated portfolio............I would suggest you revisit, and think again. Buffett is very broadly diversified.

jog on
d998


----------



## It's Snake Pliskin (28 March 2006)

Duc,

You might be going off track here. How does residential property, which we know tech invests in, and his tt system have any correlation with regard to the stockmarket?


----------



## It's Snake Pliskin (28 March 2006)

I'm interested in these points raised:


> Risk management models
> Stoplosses
> Hedging
> Diversification
> ...


----------



## ducati916 (28 March 2006)

*Snake* 



> You might be going off track here. How does residential property, which we know tech invests in, and his tt system have any correlation with regard to the stockmarket?




With regards to *tech/a* and TT, not a great deal, hence it is diversification in the true sense of the word.

However, *bullmarket* who may or may not have investment property, who may or may not own a family home, will through investments in LPT's carry a reduction within the efficiency of diversification through correlation of the same asset class...........real estate. The correlation is higher if the LPT's are residential, weaker if they are commercial, however, again under specific circumstances, the correlation can rise.

This was an example of claimed diversification and risk management, that was poorly thought out.



> I mitigate investment risk through diversification and fundamental analysis (as I described in other threads).
> 
> Nowadays I invest with income as my number 1 priority and with my current risk profile I am invested only in LPT's and energy/infrastructure trusts for their high yields.
> 
> ...




The point being that most of us own, or have a mortgage on our homes.
Some will have additional real estate exposure via investment properties.
If this describes your position, and you overweight in LPT's, is this diversification? The short answer is no.



> I'm interested in these points raised:




What interests you?
Something specific, or just generally?

jog on
d998


----------



## It's Snake Pliskin (28 March 2006)

ducati916 said:
			
		

> *Snake*
> 
> With regards to *tech/a* and TT, not a great deal, hence it is diversification in the true sense of the word.




Point taken.



> However, *bullmarket* who may or may not have investment property, who may or may not own a family home, will through investments in LPT's carry a reduction within the efficiency of diversification through correlation of the same asset class...........real estate. The correlation is higher if the LPT's are residential, weaker if they are commercial, however, again under specific circumstances, the correlation can rise.
> 
> This was an example of claimed diversification and risk management, that was poorly thought out.
> 
> ...




Clear as crystal. 



> What interests you?
> Something specific, or just generally?




All generally, but more so hedging and how it can be applied to a normal stock portfolio. 

Rock and roll all night!
Snake


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## bullmarket (28 March 2006)

Hi ducati 

I'm flattered that you are using me as an example but it seems to me you are forming opinions using assumptions which are based on extremely limited information at best  

_I see you have quite a few 'may or may nots' in your post and you have deliberately excluded assets we have in mrs bullmarket's name _ 

Now obviously I'm not going to disclose those in a forum like this but feel free to make whatever assumptions you like to base your opinions on. I posted earlier that I am happy with the returns I am getting and the level of overall risk my portfolio is carrying 

We'll just continue to watch with interest and amusement. 

cheers

bullmarket


----------



## It's Snake Pliskin (28 March 2006)

bullmarket said:
			
		

> Hi ducati
> 
> I'm flattered that you are using me as an example but it seems to me you are forming opinions using assumptions which are based on extremely limited information at best
> 
> ...




Could you please address the posts with some insight and intelligent reasoining rather than just defending yourself in general and in uninsightful ways.

You may have missed this before so I`ll repost it for you:



> Calculating risk is by no means a trvial task and so can require extensive number crunching which the average trader  would not even consider doing - and I suppose that is why no-one has posted any algorithms for actually calculating risk for a particular scenario
> 
> 
> ...being your comment, and an investor I am drawing your attention to the words in red.




I am truly interested in the above.


----------



## tech/a (28 March 2006)

> I posted earlier that I am happy with the returns I am getting and the level of overall risk my portfolio is carrying




This may come as a surprise to you but the discussion isnt about you.

Duc was giving good examples of to make his point.

Frankly I doubt anyone here could give two hoots wether your happy with what you do or not.

People are actually interested in veiws other than your own.



> deliberately excluded assets




Hell Duc I didnt know you had access to knowledge of all of Bulldusts assets!



> We'll just continue to watch with interest and amusement




Dont make yourself scarce we all need amusement as well.Even though there is little interest.


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## bullmarket (28 March 2006)

no problem tech/a 

I just called how I saw ducati's opinion and gave my reasons why....I can't be any fairer than that.

If you see his examples based on his perception of our personal circumstances as good then all well and good and I don't have a problem with that at all  

But for me, his view on what we do would have at least some credibility if he wasn't basing his opinion on very limited information on what we have and do....it's as simple as that 

see you in the soup.

bullmarket


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## It's Snake Pliskin (28 March 2006)

> I mitigate investment risk through diversification and fundamental analysis (as I described in other threads).
> 
> Nowadays I invest with income as my number 1 priority and with my current risk profile I am invested only in  LPT's and energy/infrastructure trusts for their high yields.




Is this truly diversified just to add to the diversification element. If so what is the correlation?


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## bullmarket (28 March 2006)

Hi snake 

Whether it is truly diversified or not is up to you. 

As I said in earlier posts, my porfolio is meeting our investment objectives and is well within our personal risk tolerances so for me it is sufficiently diversified for our needs.

Again, let me refer you to my signature below which clearly states my views are based on my personal circumstances only and so may not be appropriate for others.

I am just providing food for thought and people can take it for whatever they think it's worth because at the end of the day it is of no consequence to us at all 

And finally, if people want to form opinions based on very limited knowledge of our personal circumstances then that is fine but more than likely they are going to end up lookig foolish like ducati did earlier imo  for the reasons I gave earlier.

see you in the swamp 

bullmarket


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## ducati916 (28 March 2006)

*bullmarket* 

And to think I could slip that little example past you!
You had promised that you were not popping in till the end of the week.



> I'm flattered that you are using me as an example but it seems to me you are forming opinions using assumptions which are based on extremely limited information at best




Excellent, no harm done then.
Limited information........absolutely.
But I am employing some *Bayesian* reasoning to extrapolate potential asset classes that you may hold, viz. your own family home.
Of course if I am wrong, and you in point of fact rent, my abject apologies, but I've just been itching to utilize the theory (to see if it has any practical relevance you understand)



> But for me, his view on what we do would have at least some credibility if he wasn't basing his opinion on very limited information on what we have and do....it's as simple as that




Yes, I understand, but, you did say;



> I'm flattered that you are using me as an example




So of course, well, gee, you do tend to change your mind so quickly.

But seriously, as *tech/a * has intimated, this really isn't about you at all, it is simply an example of *diversification* and *correlation* and who knows, if you get really unlucky, *fat tails* and then you might really be in the soup, so to speak................



> And finally, if people want to form opinions based on very limited knowledge of our personal circumstances then that is fine but more than likely they are going to end up lookig foolish like ducati did earlier imo  for the reasons I gave earlier.




That's just not possible...........I'm a genius. Hadn't you realized?

jog on
d998


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## It's Snake Pliskin (28 March 2006)

> Hi snake
> 
> Whether it is truly diversified or not is up to you.
> 
> As I said in earlier posts, my porfolio is meeting our investment objectives and is well within our personal risk tolerances so for me it is sufficiently diversified for our needs.




Bullmarket it is not about you! It is about the discussion. Enough defence!



> Again, let me refer you to my signature below which clearly states my views are based on my personal circumstances only and so may not be appropriate for others.




Yes I am aware that you are an investor, not trader and that people should not follow you. This is why I have asked you to clarify the point about average traders not calculating risk in their trading, *but you have failed to respond to the discussion.*



> I am just providing food for thought and people can take it for whatever they think it's worth




You don`t provide anything other than defence and antagonism. I have repeatedly asked for you to validate, elucidate your ramblings but to no avail.



> And finally, if people want to form opinions based on very limited knowledge of our personal circumstances then that is fine but more than likely they are going to end up lookig foolish like ducati did earlier imo  for the reasons I gave earlier.




Once again it is not about you! It`s the discussion. This in turn makes you look foolish.

So one more time and don`t avoid it.

Could you please address the posts with some insight and intelligent reasoining rather than just defending yourself in general and in uninsightful ways.

You may have missed this before so I`ll repost it for you:




> Quote:
> Calculating risk is by no means a trvial task and so can require extensive number crunching which the average trader would not even consider doing  - and I suppose that is why no-one has posted any algorithms for actually calculating risk for a particular scenario
> 
> 
> ...




Rock on. 
Snake


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## bullmarket (28 March 2006)

*no problem ducati * 

But you should get your facts straight before posting because I never ever promised anything 

I'm retired now so our lifestyle is fairly fluid nowadays and there has been a change of plans today.

cheers

bullmarket 

*hi snake*

*you say it's not about me and I agree it shouldn't be but for some reason ducati decided to specifically mention my alias when attempting to justify his opnion in his earlier post when he could easily have chosen a generic example*.

All I did is reply to his post saying he was basing his opnion on very limited wishy-washy information surrounded by 'may or may nots' which clearly showed me has next to no idea on what he is talking about since he chose to use his very limited perception of our personal circumstances to base his opinion on. Imo he would have had much more credibility had he used a generic example....it's as simple as that 

cheers

bullmarket


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## It's Snake Pliskin (28 March 2006)

bullmarket said:
			
		

> *no problem ducati *
> But you should get your facts straight before posting because I never ever promised anything
> I'm retired now so our lifestyle is fairly fluid nowadays and there has been a change of plans today.
> 
> ...




Once again you are defending yourself instead of adding to the discussion. I`m not interested in your feelings for Duc.

Please answer my posts.

I`ll check in tonight to see your response.
I@m off to see aliens now. :alien2:


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## ducati916 (28 March 2006)

*bullmarket* 

Promises, promises, I just feel so deflated that you, whom I have such a high regard for, could mislead me so uncaringly!



> But you should get your facts straight before posting because I never ever promised anything
> 
> I'm retired now so our lifestyle is fairly fluid nowadays and there has been a change of plans today.




Of course I understand, all that liquidity engendered via endless forays into soup & swamps. I feel much better now that I understand.



> Imo he would have had much more credibility had he used a generic example..




Absolute nonsense.
Actual examples are just so superior to *theoretical examples* I use TT all the time and I will use my own later in the thread, just to show that there's no bias (you understand).

If you didn't want your methodology examined, discussed, criticised, what on earth possessed you to post it in the first place?

*Snake* 



> I`m not interested in your feelings for Duc.




You must realize, that, I am his favorite, with tech a close second.
You must not feel rejected because he doesn't want to play with you, but you must ask him questions that he wants to answer.

jog on
d998


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## bullmarket (28 March 2006)

*no problem snake * 



> I`ll check in tonight to see your response.




we won't be back home till late tonight so I doubt I'll reply tonight.

cheers

bullmarket 

*hi ducati*

no problem - I agree that normally actual examples are better but using me as an example showed me and those that no us personally that you have next to no idea on what you are talking about because the information you used in your example was extremely limited.......so as I said, we'll continue to watch with interest and amusement 

see you in the swamp 

bullmarket


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## Joe Blow (28 March 2006)

Regrettably, this thread seems to be getting increasingly personal. I don't mind a heated debate but lets try and avoid any name calling or vindictiveness.

If you can't get along with someone then it might be an idea simply to ignore them.

Some great discussion in this thread, lets try to keep it on track.


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## Julia (28 March 2006)

Joe Blow said:
			
		

> Regrettably, this thread seems to be getting increasingly personal. I don't mind a heated debate but lets try and avoid any name calling or vindictiveness.
> 
> If you can't get along with someone then it might be an idea simply to ignore them.
> 
> Some great discussion in this thread, lets try to keep it on track.




Joe,

Your warning above is, I guess, reasonable.
However, at the risk of irritating you further, may I please issue a heartfelt plea to bullmarket to throw his soup in the swamp so that we may never hear of either again.  Please, bullmarket?

Julia


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## It's Snake Pliskin (29 March 2006)

Joe Blow said:
			
		

> Regrettably, this thread seems to be getting increasingly personal. I don't mind a heated debate but lets try and avoid any name calling or vindictiveness.
> 
> If you can't get along with someone then it might be an idea simply to ignore them.
> 
> Some great discussion in this thread, lets try to keep it on track.




Joe,

Please join in. It`s good to get some others involved.


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## ducati916 (29 March 2006)

*Don Corleone* 

I came to Aussie Stock Forums because I believed in the opportunity and strong legal system. I pay my taxes, contribute, and am a law abiding citizen, regrettably, my posts have been tampered with, deleted and I suffered personal abuse.

Don Corleone, I come to your home, on your daughters wedding day, and I ask for justice.

*bullmarket* must be hung, drawn and quartered, his entrails taken to the swamp and fed to the crows in his own soupbowl...........
His very name must be stricken from the record, no record of his existence can remain for posterity.

But seriously, I doubt *MrBull* is unduely concerned, after all he seems to revel within the environment, giving as well as receiving, even after promising me personally, that he was in point of fact not appearing until the end of the week, here he was .......back again, catching me redhanded in the jar, with my fingers wrapped around his largest and finest chocolate chip cookie.
If it had all been one way traffic, then fair enough, I don't approve of *bull* ying posts either.

The actual topic of risk, is an important one, and real-life examples always make better reading than purely theoretical, as whoever designs the theoretical is open to bias in building the model........this way strengths and weaknesses are highlighted..............its nothing personal, just business!

jog on
d998


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## tech/a (29 March 2006)

So then to *quantify RISK * is in every single case subjective so to over come the problem *allocate RISK.*

This then places a bottom on the RISK that we take on any one trade.
We have control of that risk.
*Its called an INITIAL STOP*

In itself this is not sufficient enough to *Manage Risk*

What we dont have control of is the number of times our stop will be taken out in any period.---So to equate the effectiveness of our setting of a stop and its effectiveness as a money management tool we need 3 more pieces of information.

(1) Over X period (The longer the better) what was the greatest string of consecutive losses?
(2) Average consecutive losing trade.
(3) Whats is our average win to our average loss.

Without these three important pieces of information setting of a stop could be simply like filling a bucket with a hole in it.

Take it away Duc--i --san


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## ducati916 (29 March 2006)

My portfolio, which appears under Fundamental II is assessed as follows;

*Analytical model utilized* 
Fundamental analysis (Value & Cash-Flow)

*Quantification of risk model* 
Deterministic. (My testing extends from 1901 to present day, and includes 3,432 securities analyzed) *note...these are not 3,432 INDIVIDUAL securities, they are often the same security, at different points in its listed history, there have been many that have been delisted, merged, etc. This survivorship bias is overcome, as they have been done by hand from individual records, and are not extrapolated forward in time.
When I add a further 6000 examples, then it will *just qualify as a STATISTICAL model* 

*Risk management model* 
Diversification (micro, macro, geographic, strategies, asset class allocation)
*proprietary*
VAR

*Components of risk assumed* 
Slippage
Market risk

*Systemic risk assumed* 
Exchange rate 
Political

*Systemic risk allowed for* 
Inflation
Interest rates
Information flow (in regards to earnings surprises that are negative)

*Non-systemic risk allowed for* 
Psychological risk

jog on
d998


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## tech/a (29 March 2006)

Now I know why I allocate RISK.

*Deterministic.*
What has it found. What figures have you been able to extrapolate?
How are they used?
What then do you do with this information and how does it effect your trading?


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## tech/a (29 March 2006)

Duc.
Im also interested in what it is you actually derive that then gives you a measure of RISK.What are you determining?

How many individual securities make up the list which you have studied?

Where do you get Fundamental Data back over 100 yrs?
Where do you store it?


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## ducati916 (29 March 2006)

*tech/a* 

Determinism, is a philosophical argument, that has been applied to the market
Very briefly, past events and or conditions are *predictive* of future events.

Therefore you would *test* your set of conditions, historically, and going into the future.

If you had a large enough sample, long enough timeframe, robust statistical design, your deterministic sample may show statistical significance.
If too small, your results, assuming a positive outcome, are deterministic, rather than statistically significant.



> What has it found. What figures have you been able to extrapolate?




It has found, on aggregate, a 30% compounding, unleveraged return.



> How are they used?
> What then do you do with this information and how does it effect your trading?




They are used in a similar way to TT, in that you apply risk management to your *numbers* and trade them.



> Im also interested in what it is you actually derive that then gives you a measure of RISK.What are you determining?




The number of winning trades (Win%)
Average % return per trade



> How many individual securities make up the list which you have studied?




About 900 odd now.



> Where do you get Fundamental Data back over 100 yrs?
> Where do you store it?




I am a collector (investor) of First Editions, particularly finance first editions, and I have publications dating back to 1888.
A lot of the older data was collected via the Cowles Commission.

On my bookshelf baby!

jog on
d998


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## It's Snake Pliskin (29 March 2006)

Duc,

..no problem  We`ll have to agree to agree and I only call it as I see it.

Consult your bookshelf to let us know about hedging a portfolio.  This is important.

Snake


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## tech/a (29 March 2006)

Hmm

Then Duc I see we have nothing to discuss.
Your response is evasive of direct questions.
I dont believe you have mis interpreted the questions--you are far too astute for that.

There are no specifics.
At least I can be definitive in determination of risk almost instantly.(Once results have been attained)

I'll continue later.


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## ducati916 (29 March 2006)

*tech/a* 



> Im also interested in what it is you actually derive that then gives you a measure of RISK.What are you determining?




My *risk* is (amongst others) *business, or credit risk*

Market risk, or volatility is irrelevant as a metric of risk to my methodology.
Therefore there is no requirement for a stoploss as a risk management tool.
A change in the fundamentals is a trigger for an exit, and a time based exit, at 3yrs. Either one will trigger an exit. With regards to a %measure of my risk, there isn't one in the same context that you advocate, my exit may be triggered at a 10% loss, or a 90% loss, which requires a very high success rate to mitigate risk, and fairly broad diversification.

My backtested results suggest a 95% success rate or winning percentage.
The average return per winning trade is 87.5%
The average loss is 25%
Once you play with the figures over a variety of time based exits, and any losses, with the winning trades, you would return 30% compounded.

A stoploss (excluding the CFD guaranteed stoploss) is not *definitive of your risk.........a successful exit at the stop price is definitive of your risk* 

The two methodologies are just night and day.
This is why when people talk about mixing and matching Fundamentals with Technicals to create some form of superior hybrid, they are just asking for problems as the definition of risk, the quantification of risk, and the management of risk are just so different as to be for all intents and purposes incompatible.

jog on
d998


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## ducati916 (29 March 2006)

*Snake* 



> Consult your bookshelf to let us know about hedging a portfolio. This is important.




Ok, nice basic one.
This will not go into detail, but will outline the methodology.

Find an overvalued common stock.
Find one that also has a convertible bond or preferred stock as part of the capitalization.

Buy the bond long.
Sell the common short at parity, or +ve spread.
Convertible needs to be relatively close to investment value.

Wait for the common to fall.
When it falls, it will usually fall further and faster than the convertible.
If this happens, buy back the common, and sell the bond.

If nothing happens, convert the convertible into common to close the trade at breakeven, less brokerage, + any dividends or interest you accrue.

There are others, but see how that one sits with you first.
jog on
d998


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## tech/a (29 March 2006)

> My *risk* is (amongst others) *business, or credit risk*




This could alter 6 mthly if reporting is 6 mthly.What your doing is then evaluating the risk to the company and once evaluated,determining its value and I presume potential for a trade.There is a number of ratio's you could use.

Fine nothing wrong with that but I would put forward to you that that would be an excellent fundamental analysis culling of a potential universe of stocks to trade.

By trading then in a systematic/mechanical way by allocating the risk within your model of trading, I would contend that your results would improve.Infact without testing Currently this idea would have your portfolio looking a little healthier and you may well be in other more profitable trades from within your universe. Anyway perhaps you would like to combine ideas on your universe (I have the US data) and trade a parallel portfolio based upon Mechanical methodology---would have to be designed and tested.I can do that if I know your universe.



> Market risk, or volatility is irrelevant as a metric of risk to my methodology.
> Therefore there is no requirement for a stoploss as a risk management tool.
> A change in the fundamentals is a trigger for an exit, and a time based exit, at 3yrs. Either one will trigger an exit. With regards to a %measure of my risk, there isn't one in the same context that you advocate, my exit may be triggered at a 10% loss, or a 90% loss, which requires a very high success rate to mitigate risk, and fairly broad diversification.




Understand,but leaves you open to a possible 100% loss in multiple stocks.



> My backtested results suggest a 95% success rate or winning percentage.




Over what time---?? Must be over a year as reporting will only be available in detail once a year.The highest success rate I have seen with any method.Short term methods normally report high win rates and the highest I have seen variified is 72% Longterm is seen as 35-45% and this is a figure derived by systems analysts both fundamental and technical.Your current rate in your example reflects this--early days.



> The average return per winning trade is 87.5%



Again the highest I have seen,truely amazing.



> The average loss is 25%




With a 5% loss rate this is insignificant.



> Once you play with the figures over a variety of time based exits, and any losses, with the winning trades, you would return 30% compounded.




I would like to know your average trade length winners and losers.



> A stoploss (excluding the CFD guaranteed stoploss) is not *definitive of your risk.........a successful exit at the stop price is definitive of your risk*




Its definative of *INITIAL* Risk.It will limit the maximum loss on initial capital to the value assigned.Loss from highest high to exit is drawdown from maximum profit within anyone trade,thats nothing to do with initial stop losses.



> The two methodologies are just night and day.




Yes but each have benifits that maybe helpful.



> This is why when people talk about mixing and matching Fundamentals with Technicals to create some form of superior hybrid, they are just asking for problems as the definition of risk, the quantification of risk, and the management of risk are just so different as to be for all intents and purposes incompatible.




I dont think so,Its been done before and will be done again.To a degree I have done something like this (Ok loosley) with T/T.
The Fundamental analysis has been done by the Margin lender on the stocks he allows in his Margin list.That margin list is my universe of stocks that I use for trading.


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## tech/a (29 March 2006)

> Its definative of *INITIAL* Risk.It will limit the maximum loss on initial capital to the value assigned.Loss from highest high to exit is drawdown from maximum profit within anyone trade,thats nothing to do with initial stop losses.




Sorry miss read your statement.
Yes true but this is true of ANY stop or exit,if its not taken then the result will be different. This doesnt detract from the reasons for defining your risk in the first place and the benefits of doing so.


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## It's Snake Pliskin (30 March 2006)

ducati916 said:
			
		

> *Snake*
> 
> Ok, nice basic one.
> This will not go into detail, but will outline the methodology.
> ...




Duc,

Thanks for your quick reply and exemplary forum style.
I see where hedging a portfolio is quite hard work. So for say 8 stocks being hedged using the same method would acrue a lot of brokerage and be time consuming.  

Is it worth it?

Feeel free to join in all.


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## tech/a (30 March 2006)

> my exit may be triggered at a 10% loss, or a 90% loss, which requires a very high success rate to mitigate risk, and fairly broad diversification




Infact it also requires a very high reward to risk .

If a $10 stock loses $9 then the remaining stock valued at $1 needs to increase by 1000% to just return to break even. People lose sight of this when they hold a stock which continues to decline. Infact it becomes rediculous when you consider that your expecting a stock which is underperforming (To get itself in negative) to then outperform by massive amounts.



> Quantification of risk model
> Deterministic.




This is no different to ranking,you have not determined risk rather you have ranked it.Risk being uncertainty--then the uncertainty remains.
Allocating a risk then becomes a "Next Level" and its possible use has been suggested above.


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## ducati916 (30 March 2006)

*Snake* 

As to being worth it, that is really an individual choice that should be governed by your risk exposure calculation.

*Total Risk = Controlled risk - Uncontrolled risk* 
With the reward component following a similar balancing calculation.
Viz. a fully controlled reward will fall at the lower band, with highly speculative reward falling in the upper bands.

An alternative hedging strategy is the *Pairs trade* 
Here we take two common stocks exposed to the same business (an example) could be Coca-Cola & Pepsi Cola.

If (and lets assume this is the case) one is over valued, and one under valued, then we sell the over valued short, and buy the under valued long.
You are (sort of) market neutral.

Another strategy is the *Fair value hedge* 
Here we use the futures market trading price against the cash market to establish *fair value* (there will be either a premium, or discount)
Lets assume a discount, on the opening we assume a return to fair value, so sell the cash market, buy the futures...........you can work the same trade using common stocks that you follow, assuming you believe that you know how they trade.

jog on
d998


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## ducati916 (30 March 2006)

*tech/a* 



> This is no different to ranking,you have not determined risk rather you have ranked it.Risk being uncertainty--then the uncertainty remains.




In a way you could call it that. You are ranking low risk, against high risk, and loading your portfolio with low risk selections.
Through analysis you have determined that your stock selection is undervalued, and represents a bargain, thus it ranks as low risk.

Through *backtesting* the undervalued stock selections (or your ranking methodology) as a strategy have been tested to see how successful it has been. This generates the first number.........%winning trades and %losing trades.

From there, we look at the aggregate %return of the winning trades, and the aggregate %loss of the losing trades.

Lastly I look at the timeframe that these results have been generated in.
If the annual compounding rate is high enough to compensate for the *total risk, where total risk = controlled risk - uncontrolled risk* then I would assume the strategy. 



> Infact it also requires a very high reward to risk .
> 
> If a $10 stock loses $9 then the remaining stock valued at $1 needs to increase by 1000% to just return to break even. People lose sight of this when they hold a stock which continues to decline. Infact it becomes rediculous when you consider that your expecting a stock which is underperforming (To get itself in negative) to then outperform by massive amounts.




It could do, but it doesn't have to.
This is where *diversification as risk management* is so important to my overall strategy.

Lets take my starting capital at $1M
I allocate say 25% to a common stock strategy, 25% to Bonds, 25% to arbitrage, 25% to real estate.

$250K to common stocks at $12.5K (or 5% per stock selection) in a portfolio of 20 stocks. Absolute worst case scenario, you lose 100%, or 25% of your capital. But equally you could have 250 securities, each with $1K in them.
The law of large numbers starts to work in your favour, the wider the diversification, but at the expense of return, and is the basis of the insurance underwriting industry.

However, with a *determined* 95% success rate @ 85%+ return against a 5% loss rate @ 25% you are really asking how thoroughly have you researched, and how strong is the correlation. Does the correlation make sense from your understanding of finance theory (or whatever field you study)

Assuming reality follows history, then you will realize substantial profits.
That is the risk you assume, and attempt to control via your understanding of, and management of risk.

Business, or operating risk, is very different to market risk.
Technical analysis, which trades market risk, *is an extremely lagging form of analysis* and therefore must *follow the herd, and assume the herd knows what it is doing, this is the underlying theory that underpins Efficient Market theory* thus the risk management tool utilized must fully control risk, viz. *if risk = uncertainity, then uncertainity must be converted to certainity. This is the purpose of a stoploss,......a stoploss = 100% loss, therefore, there is no uncertainity, there is no risk.* 

jog on
d998


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## tech/a (30 March 2006)

> Total Risk = Controlled risk - Uncontrolled risk
> With the reward component following a similar balancing calculation.
> Viz. a fully controlled reward will fall at the lower band, with highly speculative reward falling in the upper bands.




If I set an allocation of a 5% ( of purchase price) As an initial stop where is and how would you quantify uncontrolled risk?



> In a way you could call it that. You are ranking low risk, against high risk, and loading your portfolio with low risk selections.
> Through analysis you have determined that your stock selection is undervalued, and represents a bargain, thus it ranks as low risk.
> 
> Through *backtesting* the undervalued stock selections (or your ranking methodology) as a strategy have been tested to see how successful it has been. This generates the first number.........%winning trades and %losing trades.
> ...




Not withstanding the above you still have uncertainty in any one event you are exposed to unlimited risk,with an average of 25% loss a string of even 2 losses at the high end of the "Averaging" could render your initial capital in effective if you were to liquidate the loss and highly unlikely to recover as my example above shows if you hold it.
Purchasing 10 stock with this sort of uncertainty could be catastrophic.

Take your example that your trading now. Using $50K as a trade size each trade.
To sell all stocks now that are over 10% in loss would mean massive destruction to your capital base.So your really stuck with them and hope they make up the low end of "Averages",unless ofcourse you sell those in profit as well to offset losses. So your holdng both winners and losers.

In contrast T/T has 10 stocks and everyone of them is a winner.
Simply I cut losers and hold winners.

*Diversification * is wise but still desnt negate risk mitigation in any one investment.To argue that sound diversification balances poor risk management in anyone asset is avoiding the problem not solving it.



> Business, or operating risk, is very different to market risk.




*True so I simply eliminate the effect of market risk on my business * and deal purely with my business risk.I dont have to quantify market risk,my trading model doesnt care less about actual or percieved market risk.



> Technical analysis, which trades market risk, is an extremely lagging form of analysis and therefore must follow the herd, and assume the herd knows what it is doing, this is the underlying theory that underpins Efficient Market theory thus the risk management tool utilized must fully control risk, viz. if risk = uncertainity, then uncertainity must be converted to certainity.




The herd can do whatever it likes.If it follows my trades positively then I'll stick around---negatively then I'll go away. There are no assumptions,I'm either profiting and maximising return by staying with it or its losing in which case I wont stick around very long.


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## lesm (30 March 2006)

ducati916 said:
			
		

> Business, or operating risk, is very different to market risk.
> Technical analysis, which trades market risk, *is an extremely lagging form of analysis* and therefore must *follow the herd, and assume the herd knows what it is doing, this is the underlying theory that underpins Efficient Market theory* thus the risk management tool utilized must fully control risk, viz. *if risk = uncertainity, then uncertainity must be converted to certainity. This is the purpose of a stoploss,......a stoploss = 100% loss, therefore, there is no uncertainity, there is no risk.*




Duc is spot on here.

Regardless of whether you use a 10% initial stop loss and/or a 2% trailing stop loss, it is a certainty that you are going to lose that percentage. Especially, if you are using an approach where you are waiting for the market to prove you wrong (i.e. your stop loss is hit before you exit the market/trade). This is what you see in a lot of trading systems.

The only variance is the actual realised $ value that the % stop loss equates to.

If you exit the market when a target profit (whether it is  $  or % terms) is hit then the loss will not be realised, as the stop loss has not been triggered, hence no loss incurred.

cheers.


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## tech/a (30 March 2006)

So then you would prefer not a known 2% capital loss (Allocated) but a possible 100% capital loss (Unallocated) in anyone trade.

Why?

Duc hasnt answered string of losses and average number of consecutive losses V average consecutive winners.
I can bring these important aspects into the discussion when we have 2 benchmarks--duc's and mine.

Your post aludes to this.

On lagging.
The point of a buy trigger is anything but lagging.
The make up of the analysis maybe lagging but the trigger itself is a point in time---infact its a NOW point.


On Business risk.

Yes I agree it is very different to market risk.
However it is anything but certain.
Its analysis is subjective as I doubt duc has 900 benchmark studies for all aspects of business risk studied.Operating risk can alter very quickly so again subjective.
it can also be argued that fundamental analysis in itself is also lagging badly as information cannot be found for 12 mths at time of reporting and benchmarked back over say 3 yrs.but like tech analysis at the time of completion of analysis it its on the day of reporting then there is no seen lag.

Tech analysis is no different---past to generate analysis---now for a result to supply a buy trigger.


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## Knobby22 (30 March 2006)

I disagree a little with a few statements.

There is a famous proof that some economists got a noble prize for that shows diversification reduces all risks except market risks i.e. market goes up and down. This can be protected from using options.

Secondly, though risk can't be fully quantified and analysis can be somewhat subjective, it can be estimated.
Stock picking relies on estimating competitor and environmental risks and their effect on future profits and estimating whether the market has under or over compensated for these risks. A good stockpicker who uses technical analysis as a check can do very well.

There are many ways to obviate risks and many of those ways result in giving some of the gains up. e.g. take diversification, if you follow this route to the nth degree then you will only get market returns.
Stop losses cost in transaction fees.
Options cost and can limit returns.


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## wayneL (30 March 2006)

lesm said:
			
		

> Duc is spot on here.
> 
> Regardless of whether you use a 10% initial stop loss and/or a 2% trailing stop loss, it is a certainty that you are going to lose that percentage. Especially, if you are using an approach where you are waiting for the market to prove you wrong (i.e. your stop loss is hit before you exit the market/trade). This is what you see in a lot of trading systems.
> 
> ...




Les,

Isn't that a bit of a psychological construct?

What matters is the bottom line... The discussion on risk is great, but without context when potential reward is ignored. I think trend following systems such as t/t illustrate that perfectly.

Yes, you make assured losses, and most assuredly give back a piece of profit on exit, but in the context of profits generated by the system, these risks are accounted for and overwhelmed by the reward aspect of the equation.

Bull markets illustrate another point... targets can be exceeded by a long long way! The punters are pushing stocks WAY past fair valuation IMO. 

Is it better to take a fair profit? Or better to give back a small piece of a ludicrous profit? The answer is probably what is most psychologically appealling....and the effectiveness of the individual within their chosen disipline.

 

Cheers


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## ducati916 (30 March 2006)

*tech/a* 



> If I set an allocation of a 5% ( of purchase price) As an initial stop where is and how would you quantify uncontrolled risk?




You misunderstand.
I am actually saying by setting a stoploss, you control risk.
Definition of Risk = uncertainity.
Stoploss = 100% certainity of a loss, therefore risk becomes a certain quantity. (assuming of course you don't ignore it)



> Not withstanding the above you still have uncertainty in any one event you are exposed to unlimited risk,with an average of 25% loss a string of even 2 losses at the high end of the "Averaging" could render your initial capital in effective if you were to liquidate the loss and highly unlikely to recover as my example above shows if you hold it.
> Purchasing 10 stock with this sort of uncertainty could be catastrophic.




In theory you are correct, therefore I must place further risk management in place, to mitigate the uncertainity (risk)

Returning back to my diversification or asset allocation model of 25% exposure to common stocks, 25% exposure to Bonds, 25% to Arbitrage, and 25% to real estate.

I utilize a legal structure, a Corporation, whose business is investing.
Now, lets assume I lose 100% of my investment within the common stock strategy, this can be written off as a tax loss against the income generated via the remaining investments. Therefore I have an additional layer of risk management in place to potentially offset the *risk that I have assumed* 



> In contrast T/T has 10 stocks and everyone of them is a winner.
> Simply I cut losers and hold winners.




Indeed, but I don't want to lose *any money..............not a single penny* 



> Duc hasnt answered string of losses and average number of consecutive losses V average consecutive winners.
> I can bring these important aspects into the discussion when we have 2 benchmarks--duc's and mine.




Well, indirectly I have intimated, that of my posted trades on this board, I expect to have no single trade generate a loss of any description, much less a catastrophic 100% wipeout. However, talk is cheap, action baby!



> On lagging.
> The point of a buy trigger is anything but lagging.
> The makeup of the analysis maybe lagging but the trigger itself is a point in time---infact its a NOW point.




Disagree.
The higher the price, the greater the risk, the lower the price, the lower the risk. Therefore, by definition, buying *new highs* is riskier, than buying at a lower price, additionally, it lowers your ultimate return.
The *NOW* point, is better analyzed via fundamentals, than technicals, hence, technicals are lagging.

*lesm* 



> Regardless of whether you use a 10% initial stop loss and/or a 2% trailing stop loss, it is a certainty that you are going to lose that percentage. Especially, if you are using an approach where you are waiting for the market to prove you wrong (i.e. your stop loss is hit before you exit the market/trade). This is what you see in a lot of trading systems.





Just so.

jog on
d998


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## ducati916 (30 March 2006)

*enzo* 



> Yes, you make assured losses, and most assuredly give back a piece of profit on exit, but in the context of profits generated by the system, these risks are accounted for and overwhelmed by the reward aspect of the equation.




No they are not.
TT on closed trades, returned 9% compounded over 3yrs.
This may well change as more trades are closed. However it remains to be seen how material a difference is generated. This is in a strong bullmarket, which should provide optimal conditions for the strategy.

The large $ return on capital was provided by 3.5 times leverage.
That is adding a layer of risk, to increase return.
Market conditions are a further risk factor that requires consideration, as of course market risk, is the risk that you are assuming.

Returns will always = Wins% - Loss%
The higher the number of losing trades, even if all fall inside 10%, will provide a drag on the aggregate wins% when annualised and compounded. It is astounding as to just how much of a drag.
Thus a methodology, that utilizes a low Win% or a high Loss%, becomes reliant on leverage to generate the positive returns that make it an attractive proposition.



> Bull markets illustrate another point... targets can be exceeded by a long long way! The punters are pushing stocks WAY past fair valuation IMO.




Yes they are.
So simply add a trailing stoploss, once you have reached fair value, or your profit target (in respect to a fundamentally driven methodology).
Therefore you can eliminate the weakpoints of stoploss based strategies, but maximise their advantages if you so choose.

jog on
d998


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## wayneL (30 March 2006)

T/T is but one example of a technical system. Granted it is the only one with public results with which to refer to, but we don't really have a publically traded fundamental system at this stage with which to compare with either. Yours has not had enough time.

I agree with your points re T/T .. leverage.. bull market..  etc.. even recall bringing those selfsame points up myself  



> No they are not.




But......That said, yes they are! As pointed out by yourself, the runs are on the board. Risk has been completely overwhelmed by expectancy, as expected  

Cheers


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## It's Snake Pliskin (30 March 2006)

Duc,



> if risk = uncertainity, then uncertainity must be converted to certainity. This is the purpose of a stoploss,......a stoploss = 100% loss, therefore, there is no uncertainity, there is no risk.




What is simple needs to be kept simple. 

Risk = uncertainty and exposure.
Is there a guarantee the stoploss will be hit? No. So that is your risk, because it is uncertain, and it is exposed to the market. 
If there was a guarantee, you wouldn`t take the trade.


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## It's Snake Pliskin (30 March 2006)

lesm,



> Regardless of whether you use a 10% initial stop loss and/or a 2% trailing stop loss, it is a certainty that you are going to lose that percentage.




There is no certainty that it will be hit though. Therefore it is risk.


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## tech/a (30 March 2006)

> I agree with your points re T/T .. leverage.. bull market.. etc.. even recall bringing those selfsame points up myself




Well there are some aspects which are in accurate and there are some aspects which I think are not understood or equated correctly.

There is a lot I will add using T/T as the example when I have enough time.
The points raised need a fair amount of explaination/clarification/comment.

Just quickly
Leverage is about 2.3 X and maximum initial drawdown is around 6% unleveraged so leveraged 15% of initial capital that was never hit and as the method is well underway never will be.
As for return even if every open trade was stopped at its exit of the low of the 180 day EMA drawdown on todays total capital would only be around 20% or $60k still giving the then closed % return well over that as the mean in testing.

Anyway more later.


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## wayneL (30 March 2006)

Tech,

It's not meant as a criticism of techtrader at all. As I've said before, under different circumstances than what I'm currently in, I would most certainly consider using T/T or similar.

Cheers


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## ducati916 (30 March 2006)

*tech/a* 

There has been previous mention of the *tested parametres........and should TT approach, or exceed drawdown, then it would be closed as the methodology has failed.* 

Now, by *outperforming* as apparently it has;
Does this constitute *failure* of the methodology?
Is outperformance considered a risk, viz. failure of methodology as tested?



> Leverage is about 2.3 X and maximum initial drawdown is around 6% unleveraged so leveraged 15% of initial capital that was never hit and as the method is well underway never will be.




Initial risk could well have been higher than 15% (unless utilizing the guaranteed stops)
Now, you are safe, agreed.

Without having access to all the trades taken, both open and closed, no accurate assessment can be made as to the true profitability.
Just a dollar return means nothing, apart from it tells me you might be able to afford to feed me.

jog on
d998


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## tech/a (30 March 2006)

wayneL said:
			
		

> Tech,
> 
> It's not meant as a criticism of techtrader at all. As I've said before, under different circumstances than what I'm currently in, I would most certainly consider using T/T or similar.
> 
> Cheers




Wayne

Its not taken as critisism.Dont mind if it was as long as its constructive which is what duc has said.

I actually like the method under the microscope 100s of people looking at it are bound to identify the odd thing I havent considered.
I trade it so I want to be damned sure that it does as I expect.


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## tech/a (30 March 2006)

> You misunderstand




yes I did.Pologies



> Therefore I have an additional layer of risk management in place to potentially offset the risk that I have assumed
> 
> Indeed, but I don't want to lose any money..............not a single penny




A contradiction in terms. *Reality is that we will lose some money at times * but overall we wish to be nett profitable---very profitable. Losing money in small amounts to open opportunity for larger profits is to me a wise way of managing money.The other option of locking into an investment and waiting patiently for that time to come where demand exceeds supply isnt attractive,particularly at 50+. My goal is capital gain and I cant understand people who invest purely for passive income,particularly as the value of our dollar deminishes year after year ( In 10 yrs time what will $500,000 buy you?) So If I retire at 55 and live till 85 thats a long time to support yourself as things get dearer.



> Duc hasnt answered string of losses and average number of consecutive losses V average consecutive winners.
> I can bring these important aspects into the discussion when we have 2 benchmarks--duc's and mine.




So I take it you dont have these figures.
So without them I will explain importance to those who are wondering.
If I know that my loss will be capped at 2% (as an example) and that my longest string of losses over x period of testing is say 6 then my initial worst case drawdown would be expected to be 12%.
Now if I was to trade on Margin at 2.5 leverage then thats 30% of initial capital---that would be pretty well a maximum for me with any system.
If trading CFD's then there is a potential at 10x leverage to lose 120% so from a risk veiw--I'm not going to leverage anywhere near that!

Average winners to average losers is important in that I can expect if I have say a win of 1 to every 3 losses to take around 30 losing trades to complete a fully functional portfolio of 10 stocks.So would it be wise to buy 10 stocks on day 1?---cashflow may become an issue and if trading margin a huge issue. 



> Disagree.
> The higher the price, the greater the risk, the lower the price, the lower the risk. Therefore, by definition, buying *new highs* is riskier, than buying at a lower price, additionally, it lowers your ultimate return.
> The *NOW* point, is better analyzed via fundamentals, than technicals, hence, technicals are lagging.




Im afraid I have to disagree with your disagreement.Todays high could be tommorows low from the point of veiw of today.Now take a look at the chart below.Remember that the maximum risk I allowed myself on this and any other trade is actually 1% in this case on buying.That was around 36c.
Profit on the trade was $8.10 per share.In a shorter timeframe yes true.



> TT on closed trades, returned 9% compounded over 3yrs.




Duc been through this before.The Average hold for this longterm system is over 1 yr so having open trades for longer is commonplace.Infact we have 1 over 3 yrs now and a few other over 2 yrs. Initial trades were expected to have some stop outs as the portfolio took time to do its thing ( find strong trends) so over the last 3 yrs only stops and 1 long term closed trade and a few that lasted a few months are recorded---about 9 from memory.
Open equity is massive and as I have pointed out above if all crashed to their exit around $60K of the $305K current would be lost so Say loss of $60K then payback the margin loan $70K leaves $175K on the initial $30K over 3.5 yrs.
Wouldnt be unhappy even with that!



> Returns will always = Wins% - Loss%
> The higher the number of losing trades, even if all fall inside 10%, will provide a drag on the aggregate wins% when annualised and compounded. It is astounding as to just how much of a drag.
> Thus a methodology, that utilizes a low Win% or a high Loss%, becomes reliant on leverage to generate the positive returns that make it an attractive proposition




Well thats not true either Very high profit can be generated from (and T/T does),a very high reward to risk ratio.Its actually around 12 x risk.Its not reliant on leverage we selected Margin as a method to trade back 3.5 yrs ago as most people are undercapitalised so felt this would be a good example for those with average funds looking for better return. I know of one trader using T/T who trades $700k of Super--no leverage and he seems happy!




> There has been previous mention of the tested parametres........and should TT approach, or exceed drawdown, then it would be closed as the methodology has failed.
> 
> Now, by *outperforming* as apparently it has;
> Does this constitute *failure* of the methodology?
> Is outperformance considered a risk, viz. failure of methodology as tested?





Firstly it may not have failed,it would however no longer have a blueprint that matched actual trading. Back to this in a minute.

Ive covered this before but the outperformance is the outperformance of the mean average return of 20000 portfolio's traded in Montecarlo simulation.
To explain.The highest return was say 45% and the lowest 22% un leveraged,(Just using figures to illustrate cant remember the exact ones) The results of the one I'm trading and the portfolio on the net are toward the top of the scale.
But back to the above. Thats an interesting question I have had a chance to think about since you last bought it up.
See the results are an average or all trades (Each individual portfolio) so at times then the return even for years could well be way above the highest average,yet when averaged over say 8 yrs this is not seen.
Same is true of drawdown and is defined in Maximum Peak to Valley Drawdown.This makes sence to me that if the P/V drawdown is exceeded then you stop!! However if the performance is greater than the *AVERAGE* you couldnt say its failed as you dont know the maximum growth with in the average. Even so why stop trading something that is doing better.

It could also be argued that you could and perhaps should reset the systems test x years down the track and get a "NEW BLUEPRINT" which would be different to the old.


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## lesm (30 March 2006)

wayneL said:
			
		

> Les,
> 
> Isn't that a bit of a psychological construct?
> 
> ...




Hi Wayne,

You have raised an interesting point.

If we are looking at it from a psychological view point then we could consider it as a form of positive reinforcement or building trader confidence. 

If we are fortunate enough to land a major windfall, then shouldn't we take advantage of it?

Why we are trading? Is it to create wealth, generate an income, both or more fundamentally make a profit?

If we are concerned with the bottom line, isn't realistic/pragmatic profit maximisation an aim?

To achieve any of these we can look at in terms of maximising profit. In this regard, why do we need to take an approach that fundamentally relies on the market proving us wrong?

We can use more than one strategy (exit) that enables us to protect ourselves from untoward or a sudden reversal in market direction and puts us in a position to potentially maximise the profit.

If we consider why we are using a stop loss from a risk management perspective, isn't it to reduce the consequence or impact of the market going against us. Effectively managing the downside risk.

Cheers.


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## stevo (30 March 2006)

I don't think too much about single trade risk. What is more relevant is portfolio performance over time. Many really get upset over individual trade losses but it's much better too look at performance over time. Taking a loss can be quite satisfying if it's put into the right perspective.

A 95% probability of success for a portfolio over time isn't going to make the grade. But a 50:50 chance of the next trade being a winner isn't a problem. 

The only way I can test a system *before* I trade it is through testing. Duc - what software or method do you use for backtesting? Or are your numbers from actual trading? I am sorry if I missed this in previous posts.

stevo


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## lesm (30 March 2006)

Snake Pliskin said:
			
		

> lesm,
> 
> 
> 
> There is no certainty that it will be hit though. Therefore it is risk.




Snake,

Good pickup above, but the contextual emphasis is actually on the bolded sentence below.



> Regardless of whether you use a 10% initial stop loss and/or a 2% trailing stop loss, it is a certainty that you are going to lose that percentage. *Especially, if you are using an approach where you are waiting for the market to prove you wrong (i.e. your stop loss is hit before you exit the market/trade). * This is what you see in a lot of trading systems.




It is not unusual to see systems, where the exit is based solely on a stop loss being used (hit).

It's interesting that the _The Phantom of the Pits _ identified and questioned the rationale of this approach. He also questioned why so many traders placed an emphasis on being proven wrong, by the market, as part of their trading strategy. 

My mistake, I should have been clearer in the example used, what happens when you write things quickly.

Cheers.


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## tech/a (31 March 2006)

> It is not unusual to see systems, where the exit is based solely on a stop loss being used (hit).




Dont understand.
When do you exit?

If that was the case then you either take the loss from the stop ---whatever that is or your perminently in a trade which is trading above its stop?

Do you mean Trailing stop?
If so there is a danger in this.



> We can use more than one strategy (exit) that enables us to protect ourselves from untoward or a sudden reversal in market direction and puts us in a position to potentially maximise the profit.
> 
> If we consider why we are using a stop loss from a risk management perspective, isn't it to reduce the consequence or impact of the market going against us. Effectively managing the downside risk.




Its human nature to protect initial capital and open profit.
The trailing stop and certainly the target price exit can be a two edged sword.While eliminating downside (Target) and minimising (Trailing stop) both can take you out of a trade like the one above. Leaving 100s of % without possibility of realisation.

*Its not possible to let profits run employing risk management to the up side.*


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## ducati916 (31 March 2006)

*tech/a* 



> A contradiction in terms. Reality is that we will lose some money at times but overall we wish to be nett profitable---very profitable. Losing money in small amounts to open opportunity for larger profits is to me a wise way of managing money.




No not really, just a different philosophical paradigm.
Your paradigm states; to make money, I need to lose money.
My paradigm states; to make money, don't lose money.



> The other option of locking into an investment and waiting patiently for that time to come where demand exceeds supply isnt attractive,particularly at 50+.




The volatility of financial markets is still so high relative to other asset classes that if your *risk* is correctly calculated, the issue of time is marginalised. (you old b*****d)



> ( In 10 yrs time what will $500,000 buy you?) So If I retire at 55 and live till 85 thats a long time to support yourself as things get dearer.




It should pay for dinner.



> So I take it you dont have these figures.




No.
These do not have a material impact on my results.
Reason one; the win% is so high
Reason two; I do not leverage common stocks.



> If I know that my loss will be capped at 2% (as an example) and that my longest string of losses over x period of testing is say 6 then my initial worst case drawdown would be expected to be 12%.
> Now if I was to trade on Margin at 2.5 leverage then thats 30% of initial capital---that would be pretty well a maximum for me with any system.
> If trading CFD's then there is a potential at 10x leverage to lose 120% so from a risk veiw--I'm not going to leverage anywhere near that!




And as you have illustrated, these are the reasons I do not leverage.
For myself, any or all positions may show a paper loss of up to 99%
If leveraged, and unable to make margin calls..............curtains.



> Im afraid I have to disagree with your disagreement.Todays high could be tommorows low from the point of veiw of today.Now take a look at the chart below.Remember that the maximum risk I allowed myself on this and any other trade is actually 1% in this case on buying.That was around 36c.
> Profit on the trade was $8.10 per share.In a shorter timeframe yes true.




Call your disagreement, and raise it by $60000;
If we use an example of a fixed sum, $100
Our gross risk = 100% or $0.00 (with no risk management applied)
Therefore if you pay $10 per share, you have 10 shares, with unlimited reward (in theory)

I buy the same shares at $5, I have I have 20 shares, or twice the reward potential that you do. By paying less, I have skewed the Reward/Risk ratio in my favour. By doing so, I change the risk profile.

I could also give you a breakdown of why buying a *high* price, without regard to the *value* increases your risk, but that involves a lengthy discussion into finance.

Lastly, if your new *high price* was truely *a low risk proposition as you suggest, then aggressive money management techniques would not be required, viz. a stoploss* Therefore, as I buy the undervaluation, or low price, have no need of a stoploss, and have a high success rate, low price carries less risk.

Clarification of low price being low value.
You can have a low price, that represents a gross overvaluation, and a high price that represents an undervaluation.

Technical systems do not really distinguish between the two variants.



> Duc been through this before.The Average hold for this longterm system is over 1 yr so having open trades for longer is commonplace.Infact we have 1 over 3 yrs now and a few other over 2 yrs. Initial trades were expected to have some stop outs as the portfolio took time to do its thing ( find strong trends) so over the last 3 yrs only stops and 1 long term closed trade and a few that lasted a few months are recorded---about 9 from memory.




The results of any methodology have to be measured on *actualised profit* as open profits/losses are subject to change.
The total profitability of the methodology is measured on all the trades taken.
This is why diversification lowers returns. You are diluting all positions.
TT diversifies by exiting non-productive trades as defined by initial stoploss, and remains in trades that produce. The actualised results generate the return with the timeframe accounted for as an accrural.

This is why TT on last update that I saw of closed trades had returned an actualised 9% compounded per annum. Leverage, when applied results in an actualised return of 9% * 2.5 = 22.5%/annum



> Thus a methodology, that utilizes a low Win% or a high Loss%, becomes reliant on leverage to generate the positive returns that make it an attractive proposition




But to my mind still, that is exactly what it does.
I wouldn't look twice at 9% (well actually I would)
But I most certainly would look closely at 22.5%
Which from my endless use of TT as a methodology you can see to be true.



> But back to the above. Thats an interesting question I have had a chance to think about since you last bought it up.
> See the results are an average or all trades (Each individual portfolio) so at times then the return even for years could well be way above the highest average,yet when averaged over say 8 yrs this is not seen.




And thats fine, however, could not the same reasoning be applied in reverse?
If it under performs, then over 8yrs it may come back on line?



> Same is true of drawdown and is defined in Maximum Peak to Valley Drawdown.This makes sence to me that if the P/V drawdown is exceeded then you stop!! However if the performance is greater than the AVERAGE you couldnt say its failed as you dont know the maximum growth with in the average.




Which really begs the question, if you classify failure as exceeding an arbitrary point, consistency would demand the same metric to be applied at the other end, viz. over performance. If you have this inconsistency, then the whole basis of testing is fallacious, and you might as well toss it, unless you can justify outperformance and account for the results.



> Even so why stop trading something that is doing better.




Of course, human nature being what it is, many will only question and search for weakness when adversity strikes.........if it works, don't fiddle.
This however highlights my previous concerns as to finding a methodology that works in all market conditions.

TT may be vulnerable to market conditions, it may not be. The point is do you know?



> It could also be argued that you could and perhaps should reset the systems test x years down the track and get a "NEW BLUEPRINT" which would be different to the old.




Quite possibly.

jog on
d998


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## lesm (31 March 2006)

> Its human nature to protect initial capital and open profit.
> The trailing stop and certainly the target price exit can be a two edged sword.While eliminating downside (Target) and minimising (Trailing stop) both can take you out of a trade like the one above. Leaving 100s of % without possibility of realisation.




Of course it is and that's what we need to do.

Stops that are too tight can also have the same affect, but there is nothing to stop us re-entering the trade. As you are well aware a trending stock can periodically go into a short-term ranging pattern or retracement phase. Consequently this ranging or retracement this activity may trigger the stop.

Your backtesting of T/T would have demonstrated this, as there would have been multiple entries and exits on different stocks during the backtesting period. Reduction of this behaviour would require considering the use of wider stops that would decrease the entry aand exit activity, but aware that you have tested this aspect and shown that it has no real affect on potential profitability.



> *Its not possible to let profits run employing risk management to the up side.*




There is no reference below to applying risk management to the upside, neither has it been alluded to. The focus is actually on managing downside risk and protecting profits.

Profit maximisation is possibly a poor term to use as it implies greed, but couldnt think of another way to express it at the time of writing.

I haven't ignore the first part of your post, but will consider it during the day, and provide a response later. I have been trying to be careful in using the term 'stop loss' and possibly confused terminology to a degree in doing so.

But, I would still ask the question, why do we need to wait for the market to prove us wrong in any manner or form, before exiting a trade?

If we plan our exits appropriately using the information in the chart, from both a price and volume perspective, that enables us to determine that the trend is starting to fail or lose strength exit the trade and subsequently re-enter when conditions change. 

This is similar to using chart pattern setups for identifying potential trading candidates, we can also use chart pattern analysis for identifying potential exit setups. The tools we use today are far more advanced than those of a number of years ago and it is not that difficult to include more advanced methods, as part of of our trading methodology.

cheers,


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## tech/a (31 March 2006)

> Your backtesting of T/T would have demonstrated this, as there would have been multiple entries and exits on different stocks during the backtesting period. Reduction of this behaviour would require considering the use of wider stops that would decrease the entry aand exit activity, but aware that you have tested this aspect and shown that it has no real affect on potential profitability.




Yes and the resounding result was do not set a profit target or trailing stop (of course you could and results were positive however far below the finally accepted methods results) and give the exit plenty of room. The balance comes in the length of the EMA,and thats only to smooth the curve.



> If we plan our exits appropriately using the information in the chart, from both a price and volume perspective, that enables us to determine that the trend is starting to fail or lose strength exit the trade and subsequently re-enter when conditions change.




Maybe so with a shorter term methodology such as Radges.However longer term your resultant execution will only at best have a 50/50 result,in correctness. One wrong could mean the opportunity of 300% or more is missed.
The question of available capital then comes into play.
Say I sell CTX as it looked weak at $8 and I bought Something else.
Next thing at $9.15 CTX is triggered again and there is no available funds to trade,Im fully committed.
I'm sure you see my point,diving in and out of stocks is a habit of discretionary traders who bleed to death and suffer more emotional swings than Melanie Griffiths.



> This is similar to using chart pattern setups for identifying potential trading candidates, we can also use chart pattern analysis for identifying potential exit setups. The tools we use today are far more advanced than those of a number of years ago and it is not that difficult to include more advanced methods, as part of of our trading methodology.




Sure you can have a number of exit triggers simply by having "OR" conditions or "IF" and if part of a tested methodology with its set of numbers then fine.
If your talking of multiple chart based discretionary exits then consistant profit will be very difficult,as psychological factors will come into play.


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## It's Snake Pliskin (31 March 2006)

> It's interesting that the _The Phantom of the Pits _ identified and questioned the rationale of this approach. He also questioned why so many traders placed an emphasis on being proven wrong, by the market, as part of their trading strategy.




Shouldn`t being proven right by the markets be a good reason to exit? At times I think so.


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## tech/a (31 March 2006)

Sorry Duc been flat out.





> No not really, just a different philosophical paradigm.
> Your paradigm states; to make money, I need to lose money.
> My paradigm states; to make money, don't lose money.




Actually more accurately from me is make more money than you lose,where as I accept I have to take some small losses to make the big wins.
We are different and thats a good thing I dont cost as much to feed!





> The volatility of financial markets is still so high relative to other asset classes that if your *risk* is correctly calculated, the issue of time is marginalised. (you old b*****d)




Can be.





> It should pay for dinner.




Hmm for 35 yrs--touch and go.





> No.
> These do not have a material impact on my results.
> Reason one; the win% is so high
> Reason two; I do not leverage common stocks.




Well they do if you find yourself stuck in x no of negative trades then although a loss may not be realised it certainly is there.I would rather have my un realised equity than your un realised losses.
Time could kill you.





> And as you have illustrated, these are the reasons I do not leverage.
> For myself, any or all positions may show a paper loss of up to 99%
> If leveraged, and unable to make margin calls..............curtains.




Ive never been margin called. You are removing the opportunity of making fantastic returns from other peoples money and then in turn not being in a position to compound your profits exponentially.Thats why managing RISK is so important so you/we can evail ourself to this wonderful opportunity.





> Call your disagreement, and raise it by $60000;
> If we use an example of a fixed sum, $100
> Our gross risk = 100% or $0.00 (with no risk management applied)
> Therefore if you pay $10 per share, you have 10 shares, with unlimited reward (in theory)
> ...




Its no different if you use the same methodology (well similar) Testing of 20000 portfolios tells me that the deviation on return is from 26% to 43%.
Trading more trades dilutes return only slightly but returns similar R/R ratios,Ive tested it with more trades and same capital and same trades with more capital and more trades with more capital---still around the same results with Montecarlo analysis.----if trading the same method.



> I could also give you a breakdown of why buying a *high* price, without regard to the *value* increases your risk, but that involves a lengthy discussion into finance.




I dont doubt that Duc.But if it was percieved by the market as overvalued then I would either be stopped out or the stock would go no where.Often stocks well outperform expert analysis on value.CTX was one.



> Lastly, if your new *high price* was truely *a low risk proposition as you suggest, then aggressive money management techniques would not be required, viz. a stoploss* Therefore, as I buy the undervaluation, or low price, have no need of a stoploss, and have a high success rate, low price carries less risk.




The entry isnt the low risk the method that is designed around the entry/exit/stop/position size/leverage is low risk---distinctly different.



> Clarification of low price being low value.
> You can have a low price, that represents a gross overvaluation, and a high price that represents an undervaluation.
> 
> Technical systems do not really distinguish between the two variants.




*Absolutely correct and here in lies where most get it wrong----your not trading the technicals OR if your method and numbers were designed around Fundamentals--then the Fundamental analysis---your trading a methodology PACKAGE (Or if you can associate with it better---a Business Model) which has a positive expectancy.----distinctly different again!!!*




> The results of any methodology have to be measured on *actualised profit* as open profits/losses are subject to change.
> The total profitability of the methodology is measured on all the trades taken.
> This is why diversification lowers returns. You are diluting all positions.
> TT diversifies by exiting non-productive trades as defined by initial stoploss, and remains in trades that produce. The actualised results generate the return with the timeframe accounted for as an accrural.
> ...




I see this as a fundamental attempt to varify your arguement.
Its a veiw held by yourself and if thats what you wish to set as YOUR standard then OK. BT dont as when I have increased equity I can use it they see it as good as $$s. I have drawdown yes but as long as I stay within the limits of funds used and funds available at liquidation then no Margin call.

Lets say all dropped 25% tommorow and I was called---then I would just sell however much stock was necessary to get back to with in their terms.No pain.

If I liquidated last week then I certainly would walk away with $274,000 after paying off the loan.But if you still measure it as a 9% return---OK.




> And thats fine, however, could not the same reasoning be applied in reverse?
> If it under performs, then over 8yrs it may come back on line?





Sure but if I was trading I dont have to guess it as Im out.If it then sets new parameters than if I trade it again it would be included.

If I bought a house and I thought it could go up $100K and then it goes over to $150K,Id go out and buy more houses--which I did.
Same with stocks---which I didnt it was/is mostly in houses which take months to liquidate!!,plus CGT so I have to hold for 12 mths then wait months for a sale.Some opportunities maybe recognised but cannot be taken full advantage of!!---bugga





> Which really begs the question, if you classify failure as exceeding an arbitrary point, consistency would demand the same metric to be applied at the other end, viz. over performance. If you have this inconsistency, then the whole basis of testing is fallacious, and you might as well toss it, unless you can justify outperformance and account for the results.




Your reasoning not mine.I could only be proven wrong by stopping trading and losing profit at the exit end.So I'll accept being wrong (If it ever happens) and worry about it with profit in hand.





> Of course, human nature being what it is, many will only question and search for weakness when adversity strikes.........if it works, don't fiddle.
> This however highlights my previous concerns as to finding a methodology that works in all market conditions.
> 
> TT may be vulnerable to market conditions, it may not be. The point is do you know?




T/T is very valnerable to adverse bullish conditions,its not designed for that.
So there is a good chance that at some future time it will perform poorly.
I'm looking and have been for sometime at a way of minimising the impact of a prologed down turn. Havent found anything yet that I would use but very interesting some of the ideas I'm working with.


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## lesm (1 April 2006)

Snake Pliskin said:
			
		

> Shouldn`t being proven right by the markets be a good reason to exit? At times I think so.




Snake, et al.,

There are differing views and it doesn't mean that either view is incorrect. It is important to understand the risks and consequences. Without this understanding traders financial well being can be at extreme risk with respect to more aggressive trading styles.

A similar/related thread was started on elitetraders (http://www.elitetraders.com/), but like alot of threads there it went off on tangents. It was about defensive trading, which has similarities related to the being proven wrong.

A comment/observation that was made though is that when you observe agressive traders in action, is that they are highly cognisant of the risks. This style of trading requires a particulr mindset/psycholoogy and is not for the faint hearted or risk averse. You can win and lose big in the 'wink of an eye'.

One of the biggest risks to a lot of traders is themselves.

Beginners luck can also be a dangerous trap to fall into. This can lead to overconfidence and overtrading. It may also lead to trader carelessness as they start to overlook the risks until the market savages them severely. Especially, if they stop following their plan/methodolgy and the effective risk levels increases to a dangerously high level.

The market is a hard and unforgiving task master. Markets, such as the one we have at the moment can make traders careless and overconfident.



> Absolutely correct and here in lies where most get it wrong----your not trading the technicals OR if your method and numbers were designed around Fundamentals--then the Fundamental analysis---your trading a methodology PACKAGE (Or if you can associate with it better---a Business Model) which has a positive expectancy.----distinctly different again!!!




To reiterate and reinforce tech/a's quote, this is an aspect that short/mid/long term traders need to get their heads around.

Entering a trade is simple, even using a random entry based approach.

The managment of the trade is what is critical, as this what makes or breaks any trade (winning or losing) and can save a lot of heartache. Brent Penfold in _'Trading the SPI' _ highlights this aspect, as part of what he refers to as the 'Holy Trinity'.

If anyone's interested they may like to look at the Risk Metrics site, which was setup as a specialist group by JP Morgan's (http://www.riskmetrics.com/).

Registration is free, but what may be of particular interest is the RiskMetrics Guide and the RiskMetrics Technical Guide.

cheers.


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## lesm (1 April 2006)

tech/a,

Some of this discussion may be more approprite in a thread on system design rather than risk. Happy to discuss design aspects with you anytime, here or on reef.



			
				tech/a said:
			
		

> Yes and the resounding result was do not set a profit target or trailing stop (of course you could and results were positive however far below the finally accepted methods results) and give the exit plenty of room. The balance comes in the length of the EMA,and thats only to smooth the curve.





If I can clarify what you're saying here. Is it that as long as an identified candidate stock meets the criteria you will enter trade based solely on positive expectancy?

Which means for the sake of an example if the PE is = 0.7, which means that probability of a loss is 0.3 you take the trade.

If your trade is correct then your profit could be anywhere from breakeven to whatever the market will give you, less what you give back + trading costs, depending on the level at which your exit is hit.

This where we move into the aspect of real profit as opposed to unrealised profit.

If I was looking at a worst case scenario this could even be a negative return.

Please note: that I have deliberately ignored your initial stop loss for the sake of this clarification.

If I recall correctly your exit is based on a 180 period EMA, which is a slow moving, lagging, curve fitting indicator.

Having said the above, I know that you have been doing/done work on looking at exit strategies, so accept the above as an example and not a criticism.



> Maybe so with a shorter term methodology such as Radges.However longer term your resultant execution will only at best have a 50/50 result,in correctness. One wrong could mean the opportunity of 300% or more is missed.




I understand what you are saying here, but would contend that this is based on the scope of testing and universe of tests that you have conducted and may not be totally valid/accurate in all cases. There is always a risk of giving back profits or missing opportunites, as per you comment below related to available capital.

There is also an assumption in the above that systems, such as T/T will always pick the best cases. I would contend that this sis a questionable assumption, especially if your trades are solely based on postive expectancy. Even using 'bang for buck' won't provide this level of assurance.



> The question of available capital then comes into play.
> Say I sell CTX as it looked weak at $8 and I bought Something else.
> Next thing at $9.15 CTX is triggered again and there is no available funds to trade,Im fully committed.
> I'm sure you see my point,diving in and out of stocks is a habit of discretionary traders who bleed to death and suffer more emotional swings than Melanie Griffiths.




I see your point and I am very aware of all the great work you have done over the years and your early days on stock central and reef. Therefore, I would never discount your comments without due consideration, but I will not necessarily always agree with you.

Available capital will always be a factor. How many trades could you have taken that you didn't that may have been more profitable than the ones siting in you current portfolio.

Yes, you or I could have sold CTX at $8, but around that time (sorry I haven't checked the Charts) from memory I could have bought into MBL which was trading in $22-30 range and subsequently went to around $72. Mate we could go round in circles on this particular point.

While it may sound like diving in or out of stops, it was not meant to come across that way. But, systems such as T/T have no intelligence and are actually a buy and hold style approach and there is no scope for looking/taking better better opportunities. There is no obvious concept of risk/award, neither does it or the methodology appear to consider valid situations where a stock may go into a ranging or consolidation pattern. I think that we both are well aware that stocks can go either way depending how they come out of the any pattern.

I really don't need to use or consider discretionary techniques here, as an understanding of market behaviour can go a long way to assisting and building build a reliable system. Ignorance of market behaviour can be a limiting factor from a system design perspective.



> If your talking of multiple chart based discretionary exits then consistant profit will be very difficult,as psychological factors will come into play.




NO, NO, NO, NO, not interested in this approach and agree with you on the psychological factors.

Cheers.


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## tech/a (1 April 2006)

Lesm.

Some nice stuff and contructive thought.
I will reply at length whan I have more time.
Just knocking off work now!!

I might say that I feel we are on the same page,Trades arent taken on positive expectancy alone,as I dont know from one trade to the next what that calculation may be---only that by sticking to the method the expectancy should(and has so far) return the expectancy of extensive testing.

*Thanks for your input*---yes we will also try and keep the risk issue focused but I feel that all aspects be at least discussed in brief as they are now.

Finally T/T isnt presented as "THE Trading model of models" it performs well but falls way short in my view to anything approaching perfection---still happy to trade it though. Any input as always with regard to the method which is an on going project with me is most welcome.

More later.


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## It's Snake Pliskin (1 April 2006)

Lesm good comments!  



> One of the biggest risks to a lot of traders is themselves.




This is one of the most accurate things I have read in this thread.



> Beginners luck can also be a dangerous trap to fall into. This can lead to overconfidence and overtrading. It may also lead to trader carelessness as they start to overlook the risks until the market savages them severely. Especially, if they stop following their plan/methodolgy and the effective risk levels increases to a dangerously high level.




Beginners luck is detrimental to the future of any trader. 



> The market is a hard and unforgiving task master. Markets, such as the one we have at the moment can make traders careless and overconfident.




Let it prove you right sometimes. As one realises an opportunity to sell, there must be someone with the intent to buy what you do not want. If this is not the case then you are dogs breakfast.



> The managment of the trade is what is critical, as this what makes or breaks any trade (winning or losing) and can save a lot of heartache. Brent Penfold in _'Trading the SPI' _ highlights this aspect, as part of what he refers to as the 'Holy Trinity'.




Very true.


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## lesm (1 April 2006)

Tech/a,

No problems, when you get the time.

Was concerned earlier that we may have inadvertently been on different pages.

Cheers,
lesm


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## tech/a (2 April 2006)

> One of the biggest risks to a lot of traders is themselves.




One very good reason to have a sytem and blueprint to go by.



> Available capital will always be a factor. How many trades could you have taken that you didn't that may have been more profitable than the ones siting in you current portfolio.




Montecarlo analysis tells me not many as the return is at the upper end of the 20000 portfolio tests.



> Ignorance of market behaviour can be a limiting factor from a system design perspective.




This would be clearly shown in the inability to design one.

Back to risk.
Small losses to preserve capital and then get you out of a trade quick enough so that opportunity cost (from loss of time and money in a negative trade) is minimised.
By testing your stop preferably on 1000s of trades its efficiency can be measured and its placement determined.

My tests indicate 7-10% (From intial purchase price) being the most efficient,20% being the level that will less likely be stopped out.But the downside is profits deminish as many stocks languish between the 20% stop and the initial purchase price. (Needs a 40% increase in price from a 20% loss to reach the initial purchase price!).

The whole point in this discussion is that in the end,you have a Business that has an end result of profitability,rather than disjointed segments.

However I would like to touch on a point that Duc brings up quite often with regard to the psychlogy aspect of loss and trading.
This risk I feel can be limited by trading smaller parcel sizes and smaller portfolios. Undercapitalisation and overtrading in my view are the main causes of psychological swings and the inherent RISK of these important elements of Fear---bought about by Greed.

These factors of course can be used WITH those discussed above.


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