RISK

[bullmarket]

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]

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.

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]

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]

no problem tech/a

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

see you in the swamp

bullmarket

 

[ducati916]

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]

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]

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]

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]

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]

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]

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


ice

 

[RichKid]

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?

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]

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]

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

 

[tech/a]

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]

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

 

[bullmarket]

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

 

[It's Snake Pliskin]

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]

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]

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