I thought I should provide an update on how the working relationship with Mr France is getting on. Mr France began trading a small amount of my trading capital 3-4 weeks ago. It seems that Mr France is a great trader in terms of being able to read the charts, taking positions, and particularly good at adding to winning positions. What Mr France was lacking is his understanding of risk management and this has led to repeatedly doing significant damage to various trading accounts over the last two years. This has led to us deciding to work together – combining his trading skills with my risk management skills.
I never really thought that there was a lot to know about risk management because it came quite easily to me. Now having worked with Mr France for several weeks, it makes me realise that I might have underestimated my level of knowledge in this area. Here are some examples of things we discussed in recent days:
- How to calculate your initial position size
- How much to risk per trade – how to calculate the risk in relation to the trading account size
- The need to ignore actual position size in terms of lots, and the need to focus on building a good foundation and understanding of risk management
- How position size will change depending on which currency pair you are trading – basically depending on the denomination of the instrument being traded – is it denominated in US$ (such as the US indices, crude oil, gold any fx pair ending with USD such as EURUSD or AUDUSD), in Euros (such as the DAX, CAC or other European index), or in say Australian dollars (e.g. the ASX index or EURAUD or GBPADU) or in GBP (such as the FTSE index or any pair ending in GBP such as EURGBP) – note this is not required if one is using spread-betting because the spreadbet is always expressed as a certain GBP/point (or whatever your currency is denominated in)
- If adding to an existing position – how much to add, depending on initial risk, new stop loss, and how much profit to lock in
- Managing risk ahead of significant news announcements – basically any Tier-1 news event e.g. UK 9.30am news for all GBP crosses, weekly oil inventories for oil, NFP and ECB press conference for all markets
- Managing risk on fx positions held over the weekend – and handling the opening of the markets on Sunday evening
- Reducing risk after having a bad trading session
- Handling risk increases if the account size is increased
- Managing the balance between optimal bankroll growth and minimizing the possibility of blowing up the account – this involves a discussion of the Kelly principle
- The need for consistency in always applying the same amount of risk from one trader to another
- Question of how many positions can be open simultaneously and understanding the correlation between open positions – this area must be tremendously difficult to understand because not even dozens of PhD’s and the 1997 Nobel prize winners Scholes and Merton (see Black-Scholes option pricing model) were able to correctly predict cross-correlations, which led to the bankruptcy of the Long Term Capital Management fund
- Assessing whether one is in the right state of mind to trade (physically, mentally and from a technology/resource perspective)
- Understanding rollover and financing charges (and the 10pm GMT timing and associated widening of spreads)
- Understanding whether or not to accept deposit bonuses from brokers
It looks as if Mr France is learning very quickly. He understand all these concepts I am trying to convey to him and is implementing them in his trading. So far so good.
Some time ago, I made a post about transaction costs – illustrating the concepts with the use of casino games – entitled “Trading compared to Roulette”. That post is probably quite relevant to this post.