Risk Management
The general idea is that
it is less
important to be right than to protect from being wrong. The first stone
of
risk management is a suitable money
management.
Some complements below.
Portfolio Diversification
Diversification is not and should not be an excuse for indecision. Our point of view is that it is better to diversify in strategies based on different logics than to diversify in a calculated number of stocks or sectors. The home page gives examples of strategies with very different logics.
Leverage and Stops
The choice of leveraging
positions must
take into account the maximum drawdown and a security margin. We give
always simulation results with no leverage.
We do not use stops either. A trailing stop at less than 15%
may
lower the performance and a tight stop may transform a strategy from a
winner into a loser.
Psychological Risk
Simulation and experience tell us than even a very good strategy may have a 30% drawdown and stay in negative territory during months. It is easy to imagine and harder to live. It's better to invest less money than giving up under pressure with a good strategy. Without a long term vision, the short term makes no sense.
The Luck Factor
Luck does exist. With the same probability to win (p) and the same average win/average loss ratio (w/l), your account may experience very, very different possible futures. Example with w/l=1,4 and p=50%:
That is why we select only strategies that have a clearly oriented and focused beam of possible paths. Just like the Currency ETF Strategy (see the technical summary) :
Going further in risk
evaluation, we use probabilistic indicators taking into account the
data sample size:
p95: probability with a 5% error (real probability
has a 95% chance to be higher).
K95: Kelly criterion for p95.
Every model is an approximate representation of a real phenomenon. It
is impossible to reduce the risk to zero, but it is possible to detect
when a strategy goes out of its model's normal limit.
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©
2012. All rights reserved.
