Dogs, Risk Management, And Trading

2016-02-25 | Eric Purdy

Winter is all but over here in South Texas and so I’ve resumed my morning bike rides along our rural back country roads. My chosen route for the day usually depends on how far I’m going and the current dog activity. Two things are generally true about the dogs I come across on my rides: They are rarely tied up and they don’t like MAMLs (Middle Aged Men in Lycra).
So Tuesday morning I hopped on the bike for a quick twenty miles. I elected try a few roads I hadn’t been down recently and not to bring any countermeasures along. Cookies are my usual armament. You can probably guess where I’m going with this story. About ten miles in, I spied a brown and white beast out of the corner of my eye powering toward me at a full sprint. I was caught completely off guard and went into medula oblongata panic mode. As I was just reaching full speed the dog’s mouth was open and lurching toward my calf. Then … he just licked my leg. Ok, better to be lucky than good sometimes.
The remaining ten miles got me thinking. Back in my Navy days we actively practiced what is called Operational Risk Management. In a nutshell, before each mission we would identify the risks, assess their severity, and then implement controls to mitigate them. When risk controls were insufficient to mitigate a severe risk, the decision to abort a mission could be made. I had done no ORM prior to my ride and I know better.
As I continued to ride on my thoughts drifted back to trading and how risk management applies especially well there. How many times through the years have I found myself in “fight or flight” mode, on brain stem power, making snap decisions based on fear or greed? All too often, I must admit. The common theme in these situations is usually a failure to risk manage before the trade.  Managing risk during a trade is substantially more difficult, as our judgement is often clouded by “the fog of war.”
The core mechanism for mitigating risk in a trade is position sizing. What you risk on any given trade will determine how well you will think during that trade. If your position is too large and price goes against you, your brain will turn to mush and pour out your ears. You will be peddling as fast as you can hoping the dog does not bite your leg.
There are numerous models for position sizing but I prefer to keep things very simple. For conservative trades I will risk no more than 1% of my account on the trade. For aggressive trades I will risk no more than 3% of my account. This allows me to be wrong (a lot), exit the trade, accept the loss, and move on to the next trade. No emotion. No right or wrong. Some trades work and some don’t. If the risk involved in a trade exceeds this threshold then I don’t take the trade. Managing risk is what separates those who remain in the game and those who don’t. Let’s all stay in the game.
Now off to get some cookies for today’s ride.

Catch more of Eric’s savvy on risk management, position sizing, & more HERE & don’t forget to check out his Cool Guy Video HERE