I came across a great post from Ken Grant, a founder of Risk Resources LLC and the author of the book Trading Risk: Enhanced Profitability through Risk Control.
The 10 Commandments of Risk Management
The subject of risk management, while increasingly topical in the modern financial universe, is often abused through over-analysis, over-complication and hubris among purported experts. As a longtime risk manager, I think the Number One goal of risk management, as a professional discipline, is to take complex, content-rich concepts such as transactions and portfolios, and simplify them down for the purposes of making clear-headed decisions. Do I want to do this trade or not? Am I comfortable with the amount of money I could lose in my current portfolio, based upon available information? What changes can I make if I’m not comfortable?
These are the questions that “true” risk management seeks to answer, but too often, these simple objectives are obscured by the very human tendency to over-complicate issues, derive nuanced solutions, and show mental superiority to the world at large.
Do you want to be the smartest guy in the room or the richest? Most would choose the second option, and, while risk management can be of enormous assistance in achieving this objective, it is only one tool in the trading/portfolio management arsenal, and the simpler it is to use the better.
Trends towards simplification of objectives and ease of interpretation are beginning to work their way into the murky field of risk management, and the purpose of this piece is to provide you with some basic guidelines – the 10 Commandments – which, if you follow them, will give you an enormous edge over many market participants who routinely violate them.
It may or may not surprise you to learn that my 10 commandments, like the ones that came down from the biblical Mount Sinai, are mostly blindingly simple rules of common sense. It is a constant wonderment to me that they need to be articulated at all, but – trust me on this one – even the most sophisticated portfolio managers routinely violate them. However, this is also true of Moses’ tablets, as, even the most righteous among us will occasionally lie, covet our neighbor’s wife, or fail to honor our fathers and mothers.
So I offer the following set of simple rules, with the forewarning that, like biblical teachings, the enumerating of them is a much easier task than living by them.
- Commandment I: Establish/Understand Market Participation Objectives.
- Commandment II: Establish an Investment Approach that is Consistent with Commandment I Outcomes.
- Commandment III: Establish Financial Objectives and Constraints.
- Commandment IV: Stick to Your Methodology.
- Commandment V: Understand the Profitability Dynamics of Your Portfolio.
- Commandment VI: Understand the Volatility Dynamics of Your Portfolio.
- Commandment VII: You Are Able to Risk More When You’re up than When You’re Down.
- Commandment VIII: Set Targets for All Individual Positions/Themes and Stick to Them.
- Commandment IX: Fear Not Options, Including Their Short Sale.
- Commandment X: Obey the 10 Commandments
You can read the full article here.
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