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I realized that a lot of our conversation around Risk and Loss is not conducive for an optimal mindset for trading. As a matter of fact, the concept of risk and loss as we see in other life situations doesn't apply for trading. Understanding this will help us see the real opportunity in "Risk and Loss" while trading.

Trading is based on probability. Any given trade has a probability to Win BIG or Loose Small. Loosing small is a mandatory requirement for Winning Big and letting the probability to work in the long run.

As you can see any system with a positive expectancy will produce a profit in the long run Provided we take small looses on the way. It is how probability works.

In conclusion, If you are using a system with positive expectancy and have the discipline to follow it, there is no Risk in trading, there is only Opportunity to either Win Big or Loose small in any trade for the greater good of turning a profit in the long run.

Last edited by rahulgopi; February 20th, 2015 at 05:46 PM.

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real risk of trading is beyond profit or loss . you loose your time ,your best times that can be spend wit family ,friends, etc.. you glaze your eyes over charts and you will have a virtual life. you lose at least 5 years of your age in order to find a trading system. ( i can not believe anyone can find a system less than 4-5 years of trying hard)
but speaking in terms of real risk ,there is no guarantee about the risk , even if you risk 1% of your equity ,there would be the possibility of 100 times of loss in a row.every thing is possible , so modeling risk in mathematical manner is just making yourself fool. Nichols Nasim Taleb (PHD in statistics)says : even in the best financial engineering departments in universities,there would be nothing more than wrong ideas and pseudo science .
some years ago two Nobel Prize winners of Economy science ,started a investment fund in USA. they implemented all modern theories and mathematical aspects of controlling risk .but their fund fell in the market .as a human we can not measure "real risk" of anything.trading is not an exception

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Taleb is right in that a lot of the investment / portfolio and risk management taught at university is a pseudo-science. It is all based on trying to fit into the current accepted efficient market model which implies that all of us on this forum are wasting our time since we can't beat the market anyway.

The two Nobel Prize winners (Myron Scholes and Robert Merton) did not start LTCM, it was started by John Meriwether who was a top bond trader at Salomon Brothers. If I recall correctly they were involved as partners, but it did not sound like they were that involved in the day-to-day trading of the fund. LTCM traded statiscal arbitrage strategies and these strategies are based on correlation between instruments staying roughly the same. If these correlation stay the same, you can model how prices should behave. This worked extremely well for LTCM until Russia defaulted on its debt and several of the correlations did not hold. LTCM could have survived, but they martingaled onto their existing losers and it just snowballed out of control. It was mostly ego that caused those losses. The book "When Genius Failed" goes into a lot more detail than I can here.

Regarding the "measuring of real risk", most strategies that use stop-losses and concentration limits are quite good at limiting risk. They don't really try and "measure" risk, but those strategies know how much an account can lose if all stops are hit and executed within defined slippage parameters. Thus, it is easier to control risk, but measuring risk with VAR tends to be a pointless exercise.

On another note, your entire account is always at risk - your broker can declare bankruptcy at any time...

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i agree with you,they did not consider Russia as a major risk in their portfolio.the fact is that we as human kind are UNABLE to measure risks .with stop loss we just limit our risks and at the other hand we "increase" opportunity factor of risking.it's possible to have 100 losing trades in a row.even if you risk 1% of your equity.BTW i think "real risk" of trading is somehow much more than what we consider .it's been always my own question that if reward (money) of trading is greater than it's hidden risk...

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If you risk 1% of your capital your risk will be reduced as your capital is depleted. After 100 losses you would still have about 1/3 of your capital remaining.

After 10 losses in a row I would take a long hard look at my trading strategy, and more than likely reduce my risk per trade until I determined the problem.

My record is 23 losses in a row. The problem was the trader not the strategy.

It is hard to find the Truth when you start your search with a preconceived notion of what the Truth will be.

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as long as your equity is reducing , your risk will be INCREASED.if you 've a modest trading account of 10k and each time you risk only 100$,whenever your equity is 8k,then 100$ is not 1% of your equity .
as you pointed, draw downs have additional pressure on mind , so they are additional hidden risk too

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The key is to have a system with positive expectancy and have the discipline to follow it. IS there a probability to get all loosing trades in a row and washout your account? probable but chances are very less. We are emotional beings, once we see a number of losers, the first intention is to tweak the system or to look for a new one. Traders who succeed are the ones who have confidence in their method, have the gut to follow it, not to be fearful about handful of losses as they know the probability will work in the long run.

A casino is a good example of a system with positive expectancy that work in the long run. It is the law of big numbers and probability. Most games have a very slight edge for the casino but it will work in favor of casino with a large number of plays.

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