IFTA: Defining and Managing Risk in Trading System Development and …

The Four Faces of Risk: Defining and Managing Risk in Trading System Development and Trading Management
Risk is the pri­ma­ry limi­ta­ti­on to tra­ding pro­fits. In the deve­lo­p­ment of tra­ding sys­tems and manage­ment of tra­ding, risk appears in four situations:
  1. Per­so­nal risk tole­rance. Each trader -- per­son or tra­ding com­pa­ny -- has a risk tole­rance. It is the amount of draw­down in the tra­ding account whe­re the trader loses con­fi­dence in the sys­tem and takes it off line.
  2. Risk inher­ent in the pri­ce series. Each pri­ma­ry data series -- the pri­ce series of the issue being traded -- has risk inher­ent in it. That risk can be mea­su­red and used to deter­mi­ne the sui­ta­bi­li­ty of an issue for trading
  3. Risk of a tra­ding sys­tem. The tra­ding sys­tem -- the model (the com­bi­na­ti­on of indi­ca­tors, para­me­ters, and rules) tog­e­ther with the data -- has both risk and pro­fit poten­ti­al. Risk of the sys­tem can be mea­su­red, maxi­mum posi­ti­on size deter­mi­ned, and pro­fit poten­ti­al estimated.
  4. Risk manage­ment as con­di­ti­ons chan­ge. As tra­ding con­di­ti­ons chan­ge, risk chan­ges. Risk can be asses­sed trade-by-trade, enab­ling the trader to deter­mi­ne the cur­rent maxi­mum safe posi­ti­on size, and to compa­re alter­na­ti­ve tra­ding opportunities.

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