You can think of this book as a practical guide to the art and science of risk management. It's not like we're going to completely ignore the concept of risk assessment, which, as far as I can tell, is the overarching obsession of the risk management literature published so far.
Acknowledgments
I also want to thank my editor, Pamela van Giessen, who has hung in there through many fits and starts over the past half decade and whose patience and guidance have been a driving force in bringing this material to publication. Finally, and at the risk of descending beyond the point of extreme sentimentality, I would like to thank my wife, Deanna, and my children, Brianna and Alex, for making the journey a joyous and worthwhile one and for from time to time forcing time to be at my best, whether I wanted to be or not.
The Risk Management
Investment
I know it's getting later in the year and you're eager to dial back your performance so you can get paid. For starters, you've lost a lot of money, further depleting your risk capital at a very inopportune time.
Setting
Remember, we're talking about investment here, which involves allocating scarce resources - by which I mean resources that I assume you can't afford to waste. On the other hand, we've had enough input (or will within a few chapters) to create, if we were so inclined, a mosaic of goals of self-destructive complexity.
Performance Objectives
But I know of many bad reasons and the first one that comes to mind is that you are confident in the success of your trading model. Take a trip, preferably out of the country (or at least out of the time zone).
Understanding the Profit/Loss
Patterns over Time
He is paid a percentage of the profits of this latest (most lucrative) gig every December 31st. If this portfolio were a stock, it would be one of the last things in the world you would want to own. This other core element of statistical analysis is somewhat elusive to define, but it is one of the most important components of our toolkit.
The standard deviation of a normal distribution is indicated by the width of the shaded bands illustrated in Figure 3.5. A low standard deviation is one where most of the observations in a given distribution are close to the mean data point. In order to calculate the most accurate version of the standard deviation (which, we should remember, is just an estimate of portfolio exposure and as such will never be completely accurate under any methodology), it is necessary to adjust the capital figure on a daily basis to reflect this P/L impact.
When calculating the Sharpe ratio, the risk-free return is subtracted from the portfolio's total return to isolate the portion of performance that is tied to the assumption of market exposure. Due to the specifics of the calculation (in which the number varies directly with the square root of the number of data points), this requires multiplying or dividing by the square root of the number of observations. This is a simple percentage representation of the number of days your trade ended in profit.
If you want to be creative, it might be interesting to compare your correlation with the stock markets to the average beta of the securities in your portfolio.). This type of correlation analysis involves calculating statistics for different trading accounts.
The Risk
Components of an Individual
Portfolio
The following is a brief description of the possible application of statistical tools in measuring the risk characteristics of individual market positions. It is hardly an exaggeration to say that they provide the backdrop for the development of the theory and practice of risk management in the institutional segment of the market (where it all started). In the meantime, however, you can apply the concept in a much more simplistic form by sizing your individual trades in terms of the associated volatility you are willing to accept for each trade.
As a final point about historical volatility, it's important to note that the results you get will vary with the length of the data set you use. Implied volatility is a measure of the amount of expected price dispersion at a given value in a prospect. I would simply add that using sound correlation data in managing these activities can only increase the efficiency of the process.
It is in these highfalutin environments that the keepers of the sacred risk management flame set about creating their masterpiece—the infamous Black Box (Boitte Noire). However, there are scenarios under which these portfolios (perhaps due to the demands of the firms that offer leverage to convertible. Specifically, it is important to be aware of the "technical" characteristics of the financial instruments that you trade.
Setting Appropriate
How can I establish appropriate exposure ranges for my trading so that my risk is neither excessive nor too low to achieve my goals. What should I do to adjust my risk profile if I feel it is either too high or too low? He wants to play words to a world that doesn't speak, he wants to play people playing hide and seek.
He wants to play riff for the guy with the wires, he wants to play lead but his hand is getting tired, he just wants to play but he doesn't know how to say it.
Rule 1)
Indeed, as we have already covered, some of the most important work done in the era of financial engineering is the expression of return in units of risk. It is also a measure of the amount of return you are likely to generate for a given dollar of risk, which, as argued earlier, is a concept most succinctly expressed in the portfolio volatility statistic. We take target return, risk-free rate and Sustainable Sharpe as constant in this analysis, which means in the case of Sustainable.
However, the 20-day average volatility is a very good indicator of the types of risk you are currently taking. Now let's assume you make an extra $1 million during the first quarter of the year. Some of the world's savviest commodity traders had been predicting such a shift in sentiment for many a month.
Even if it isn't, it almost always seems like it is from the trader's point of view. He too was a world-renowned collector and had many similar treasures. In fact, he was one of the first sellers of the things Doofus bought.
Adjusting Portfolio
Open this chapter by offering a mad hat of props to one of the best (and, sadly, unknown, at least in the States) bands since the Beatles. Feel free to blame me if this turns out badly; but in doing so, remember to temper justice with mercy, as I have always done with you (well, almost always - that time you doubled your 10-year note position before the monthly earnings report, you deserved every - thing you got taken from me, and then some). Throughout the previous discussion, I've emphasized the critical importance of adjusting your exposure to account for your performance relative to your objectives, for drawdown management, and for other realities of the profit/loss (P/L) cycle.
Rule 2)
One common misconception is that to be a successful long/short player, it is necessary to operate profitably on both sides of the market. Heck, there are even rumors going around (though not started by me) that you were part of the clinical trials and had a great experience in the process. Moreover, in these circumstances it would be logical (and perhaps even desirable in some cases) that the total P/E for the hedge side of the market would be negative.
As a final point, it is important to consider the diminishing returns of diversification. For our purposes, leverage can be defined as the ratio of the economic value of a given portfolio to. However, it is important to be aware of the restrictions that will apply to your leverage activities.
To understand the underlying causes of this anomaly, it is simply necessary to review the basic dynamics of the transaction. Under these circumstances, the seller of the option is faced with exactly the opposite return dynamics. To understand this, we need to return again to the principles of options trading itself.
Trade
On the other hand, if you want to maximize your performance in the markets, it is important to develop a solid and consistent quantitative handle on your performance at the level of the individual transaction. In order to perform an effective analysis of the transactions that make up your portfolio, it is clearly necessary to collect and store all visible and relevant aspects of the individual trade. This is defined as the sum of the dollar values of your longs and shorts.
By calculating a weighted average, we get a sense of the relative investment return associated with the portfolio at the transaction level. The following topics are a subset of the types of correlation analysis you can calculate between your own portfolio patterns and your profitability. This correlation statistic measures the level at which your profitability is either a positive or a negative function of the actual amount of dollars you put to work in the market.
My guess is that you will see patterns that are correctable in terms of the size of your bets. As one measure of the effectiveness of your diversification program, you may want to examine the extent to which your portfolio performs better or worse as the number of names you have on the sheets increases and decreases. It contains a healthy component of the type of correlation analysis described in this chapter.
