@ risk management and trading psychology

Risk Management & Trading Psychology

• You can this content online too if you search hard for it. 
• Information is fragmented and there’s no continuity
• Gave me an opportunity responsibility to create content around topic
• As complete information as possible

Risk Management

• Every cent you lose is gained by another person. 
• Trading is about 80% risk management and 20% strategy

Types of risk

• Unsystematic risk: It’s due to company-specific reasons. Can be avoided by diversification. Invest in multiple companies. Have no more than 15–20 companies in a portfolio at a time.
• Systematic risk: Common to all stocks. Due to different factors such as macroeconomic policies, political situations, instability and other factors influencing market. Inherent in the system. Can’t be diversified. Cna be hedged to get rid of the risk. Hedging= carrying an umbrella when you see the bad weather. Hedging not same as diversification but a good way to minimize risk.

Expected Return

It plays a major role in managing risk.

Variance

Dispersion of daily returns over the expected average return. Higher variance= higher risk

Co-variance

• Relationship between stocks and how returns in them will vary. 
• Finds the relationship between stocks. When one increases, what happens to the other?

Equity curve

• Way to visualize the performance of the portfolio. 

Expected Return

• Amount of return you want on the invested amount. 

Portfolio Optimization

Returns on portfolio directly dependent on weights assigned to individual stock. Different types of portfolio:

• Minimum variance portfolio: minimum risk
• Maximum return portfolio: High risk

Value at risk

The worst-case scenario that can occur the next morning is value at risk.

Position Sizing

• Gamblers fallacy: Faced with consecutive losses, thinking the next trade will be a winner is high chance. New trade has same odds that your first trade had. 
• Position sizing is antidote to gamblers fallacy
• Having money to play the game in long-term is better than making money in the short term. Stay consistent and position your sizes.
• Learn to position the size of your capital well. 

There is no certainty in the market. There is no single technique that will tell you the future in advance. But on the basis of how meaningful your analysis your odds of winning can be improved. But you have to accept the fact that the markets are random and there is no certainty in the market.

Equity capital

Equity capital that’s the total amount of capital you exposed to the risk. And estimating equity capital is the crucial.

• Don’t risk more than 1–3% of your capital on a single trade.
• Simplify your trading system

Common Trading Biases

When we analyze data, we don’t just analyze it. We try to be smart and add our imagination to the data. This imagination originates from the interpretation of an ideal world. They are referred as biases. 

In trading, the only thing standing between you and your profitable profit or loss is these biases.

Illusion of control

• Making charts and analysis complex and trying to make sense out of it. 
• Gives you a feeling that you are fully in control and you know what’s going to happen next.
• Remember: The market is random. You can’t control the outcomes no matter how many indicators you use.
• overcomplicating charts make them feel like they are invincible and gives them a sense of control
• Use a data-driven approach and don’t get sued by inputs

Recency Bias

• Distorts the sense of judgment by making you see the recent event far higher than you probably should. 
• Gets you carried away by recent information
• You turn blind eye to past events or facts. 
• To avoid this, take a look at the wider picture instead of microscopic view.

Anchoring Bias

• We compare information to the first piece of information we have about that topic.

Functional Fixedness

• Start thinking outside of the box to solve problems. Use conventional ways. Don’t stick to traditional ways.
• It limits people from using tools only in a traditional way.

Confirmation bias

• You look for pieces of information that support your previous point of view. 
• You collect information that supports your point of view and reject any other contradicting ideas.

Attribution bias

• Makes you think that the victories are yours and losses are the result of the fault of others

To overcome trading baises, maintain a journal and write about your emotions, why you take the trade, and what you learned from the trade.