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Why don't more traders offload their risk management?
We've always been told to treat your trading like a business. Yet I think many fail to do so. In particular, controlling their risk.
When you look at a prop trading firm, they have dedicated risk managers. If the traders reach their daily stop, the risk manager will assess the traders, take their emotional temperature, and decide whether to give them additional capital to trade with. Same goes if the trader wants to size up. They must have supporting evidence.
Why? I believe it's because they treat it like a business. They don't trust any individual to have the consistency to never succumb to their emotions.
So that begs the question, if the professionals are outsourcing their risk management, why aren't more retail traders doing the same? There are multiple platforms that support it, some platforms have third party tools and I'm sure brokers would be happy to add in a daily stop.
How strong of a business would it be, if the only thing stopping you from blowing up the account, is you?
This is from the point of a single person starting a business; Most people who attempt to start any business fail at least once and for a lot of people multiple times before finding something that works or finding out running their own business is not for them. IMO any new startup has a high degree of risk. This is what you need (risk) to see if it’s going to work. Plus you don’t know what you know, which leads to failure and learning. Through this pain arises risk management.
To answer your original question as to why more retail traders don’t use risk management I think it depends where you are in your journey. If you make it to the point of making money then risk management becomes essential to keeping your wealth. If your just starting out, your trying to figure out what sticks and risking a lot more per trade because you don’t know any better.
You're looking at it backwards.
Professionals aren't outsourcing their risk management.
It's the FIRM who is withholding the risk management privileges, and not delegating it to its employee traders. It's the firm's risk, not the traders'.
As a former R&D manager, I can tell you that no business outsources its core capabilities. Otherwise - who needs that business? Everyone can just go directy to the subcontractor... The justification for existence as a business is it's core capability (the "edge").
As a trader, risk management is THE most important thing you do. Your attitude should be to own up to it and claim full responsibility for the most important part of your trading business, not look to alleviate pressure by leaving such responsibility in the hands of someone else.
Yex, the only thing stopping you from blowing up your account is you. That's a good thing. It keeps your mind as the "business manager" on the most important part of your business.
In your example, the trading firm keeps risk management as its core capability, and "outsources" execution to the individual traders.
Think of algo traders as another example: they may "outsource execution" to the algo, but still make their own capital allocation decisions.
I think this is false. If you can't generate ideas, there is nothing to manage when lack of quality ideas drives your account south. If you can generate quality ideas, but you are reckless and don't manage risk properly - you will still win.
Risk management is not static. Big firms can afford to use conservative size because of the sheer amount of capital. Making ten percent on a $100 mln account will pay lots of salaries at a management firm, while making it on a 10k account will make very little difference to someone's financial affairs. I am not saying someone with a small account should take stupid risks, but money management for a small trader has to be more creative.
And yes, I personally believe that risk management is THE most important part of trading. It is in a way similar to boxing: you can have the most powerful punch in the world, but if you get knocked out before you can demonstrate your power it is useless.
It think to a point he's right- without a profit generating system- it's nothing but risk ................ what's to manage? It's a downward account balance trend with occasional positive blips. But when someone systematically back tests stop loss levels- they are doing a system wide risk assessment. And with a hugely profitable system- trade mismanagement degrades profit but doesn't destroy it. I would think that most large profitable hedge funds risk management is built into their systems- yet fund management efficiency is paramount.
There are ways to trade the equity curve, so a mediocre system (in some instances a losing one) system may become profitable.
I would like to see a system that is indestructible by poor risk management.
In my experience with testing systems there is always a trade off. High winning rate will be offset by a small ratio of winning/losing amount in dollars/points. In other words you will have many small wins and fewer, but much larger, losses. High winning rate and high ratio of net wins and net losses will have a large intra-trade drawdown. Massive wins - low winning rate. And so on. Without proper money management one or another of these things will catch up with you.
LTCM was managed by the best and the brightest. Why did they fail? Overexposure.
Indestructible is a strong word, let's face reality, we'd live in a country where someone has worked for 30 years and never made more then 40k a year wins 40 million in a lottery and are bankrupt within 5 years....
I guess my point is if you're smart enough to build a 'hugly' profitable system I would think you'd have at least an eye on risk management and I actually said 'trade mismanagement '.
I've tried equity curve trading my system to smooth the returns, it worked better on paper (in theory) for previous years then it did trading it live (in reality!)
