Risk

T HE ANSWER TO BECOMING
P R O F I TA B L E
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The reason most people start

100% Win
Bullshit! All of it.
The reason people start is to make money but over 90% fail. The question then becomes:

WHY do they fail?

RISK
Risk doesn’t have pretty charts; It doesn’t have fancy indicators and it certainly does have much
attention. Everybody says control your risk. Period end of sentence.

RISK is a single work but has variable measures or areas of impact.

This class will bring to the discussion the idea of RISK management and present various views on
ways to control the negative impact trading can have.
The same pie but different slices
Let's define the personal variables in every trader’s business. Then there are unknown variables.
1. Trading styles are different
2. Risk appetite is different
3. Account size is different
4. Volatility is not suitable for your account size.
Obviously, nothing new here BUT there are some questions you need to ask.
1. Is my appetite for risk aligned with my trading style.
1. You can be using the wrong style for your risk appetite.
2. Or perhaps your trading style requires greater risk [drawdown] to be profitable.
2. Can my account support my trading style.
1. If your trading style is successful but takes large drawdowns can your account handle it.
3. Does the risk my account accept fit into current market conditions.
1. Can I afford the drawdown with this volatility.
Known Unknown

Every time you step in the sand box every one of these factors can affect the outcome.
 You then focus your efforts here Circle of life for new traders

K
N Acct. Range
O System Risk
Size Vol.
W
N

U
K
N Geo Social
News Weather
O Political Media Do not have trades on during
W known news cycles. Don’t even
N try trading after the report.

You know how you trade and what your account value is.
What your focused on is the perfect system
Where you need to focus is how does my style of trade react with the volatility and can I support that RISK.
 System or
Style

Momentum Mean
Scalping Fundamental W.A.G
Or Breakout Reversion

Define how you trade.

1. What style are you most aligned with? You will only trade your personality.
2. What drawdown has that style incurred before going profitable? MAE
3. At what point does the drawdown become a point of no return?
4. Can you live with that size drawdown?
5. What is the maximum return can you expect? MFE
With Scalping, Momentum, Mean Reversion and Fundamental trading you can determine these metrics
It’s the WAG trader that cannot determine risk.

In this business if you don’t have a plan you will fail.

There is no right or wrong
The old saying “let your profits run and cut your losers short” is wonderful but why don’t you tell me
how to do that. That’s exactly why we started with risk.

I will document Rosses style and risk controls and he will provide examples.
I will document my own style and risk controls and I will provide examples.

We then examine the method you could use to test your risk controls.
Ross
Longer term plan identifies LVN areas from historical volume by price
charts a static reference point
Prior day Range and Close used as reference targets static reference
points
Prior day Value area marked and used as reference to determine a
shift in value a static reference zone
20K Trade chart used to plot the price action and how it interacts with
the static areas above.
Bollinger Bands used to provide a visual sense of price extremes with
upper and lower bands defining extremes and the average being used
as the reversion point.
Predominantly looking for a confluence of Bollinger band extremes in
the area of prior planning and entering a trade on an imbalance of
trade opposite of the previous short-term 20K trend.
Has predetermined areas used for break-out trades [momentum]
Will use BAR-POC to gauge trade entry. [momentum]
Trades all in / all out rarely adds to an existing trade.
Gary
Long term plan looks at COT report to identify disparity in trade. COT
determines trade side emphasis
Daily charts used like Ross but focused on the Delta in the vicinity of
the LVN. I pay close attention to HVN of prior days with notes made to
Naked VPOC that bracket the current day.
Volume anomalies identified on daily chart. Areas marked based
abnormally high volume at price, abnormally high volume on the Bid
and abnormally high volume on the ask.
20K trade chart used in similar fashion but emphasis placed on place
on large bar delta breaking the Bollinger band while noting trade
anomalies. P&F chart used to define trade range.
Confluence of prior static zones being entered with extremely high bar
delta and trade anomalies start to form a trade signal. Floor trader
pivots used as target and add to the validity of the other items.
Targets are determined buy session delta. A break of a high Delta
area for the session make it a point to review for adding if tested from
the other side.
Will not trade a break-out but may fade the break-out based on Delta
[reversion]
Will use BAR-POC or BAR IMBALANCE zone aligned with session delta
at price for adding or entry. [momentum]
Treats each initial trade as a scalp leaving runners to work. Focus is
adding to existing trade
That basically describes how each gets to the execution point. Upon execution risk and target parameters
are put into place. Both trade quite similar. Let's examine the Risk and target difference.

Ross
In the ES
On a signal area such as a LVN the trade is a
reversal bar and execution is the following bar if two
of these three are present: imbalance, faded
volume or completed auction.
Risk
A Stop is place approximately 7 ticks from the bars
low/high Trade size is fixed at usually 3 lot with 2
lot target at 7 ticks. Stop trailed to breakeven. The
final runner is managed individually
See Illustration on next page

I want to be clear on this; The issue is risk and these illustrations are done after trading hours.
enty's and targets are based on actual fills. These presentations are based on theory.

Upon the review of a trade Ross may have taken I will explain the trade I [Gary] would take. Conditions are exactly
the same, Same day, same time
 After target 1 is hit, the 1 remaining position is open.
Stop has trailed to Break Even

For educational purposes we will assume the last

Contract was stopped out at BE

Target 1
Fill
Stop

Aggressive selling volume

fading, buying imbalance
developed on a completed auction
Imbalance Identifier
All 3 criteria were present.
Ross had about 2P of risk X 3 contracts or 6Points total with a gain of 4P

Gary Risk
On a signal area such as a LVN the trade is a reversal Risk is defined by the market structure. The stop is
bar. [Change Point] Bar Delta is then observed with set wide as a disaster stop and adjusted into price.
delta at price. [Note: I said into the price not away from the price]
upon setting the stop it will not move after the first
contracts are taken off.
See illustration on next page

This discussion is about RISK not about a signal to enter. Do Not mistake that. Do not do this if you’re new
to trading. When I am wrong, I am wrong Biggly!

Lets define the parameters. I would trade in units 1 Unit = 3 Mini, Then I switched to 1 unit = 30 micro put on
in smaller units of 5. Then switched again to today and the only units I want are educational.
 This set my trade stage.

[A] Large bar delta break below lower band. Stage set
[B] Finish volume high and ask/bid spread small. Signal bar
[C] Anomaly Negative price movement positive delta. Absorption
[D] Large negative delta with reduced range. Absorption
[E] No positive delta at price in fading session volume. [Note 1]
[F] Min Delta only -103 and price started moving higher.

AB CDF
[G] Was entry bar in approximate area of bar POC F: Target 4
(a) Entry 1 = 1 unit
(b) Target 1 = 2P on 2 and holding.
[H] Has even greater reduced Min Delta and upon reversing from the low an add should be made.
[H] was also an anomaly bar indicating price range is attractive
(c) Add 1 unit Inventory 4 Contracts
(d) Target 2 hit 3P on 1 This was the (a) entry runner. Break Even now moved to (c) Entry 2
(e) Target 3 1 off 8P inventory 2
(f) Target 4 1 off 22P inventory 1

Inventory would be 1 contract and 36 P excluding open position.

Initial risk was 21 Points on original unit.

Disaster Risk was 45P on trade inception. E: Target 3
D: Target 2
B: Target 1

A: Entry 1

C: Entry 2 Add

Stop started at 15P and immediately moved to 1P under low.

GHI J
 Risk vision for 2 different traders in the same trade location with the same size trade.
Ross
Enters on a specific chart identifier that defines his risk
tolerance. If the imbalance goes away, Ross knows he is
wrong.
Targets are at 7 ticks and the runner is managed manually
with a break even stop [Trailed to BE by software]
Total risk is 5.25P per trade
Gary
Enters on more of an interpretation of trade from 2
different areas Bar Delta and Delta at price.
Risk is defined by the chart essentially the same as Ross
but the low of the chart is used as the reference.
Targets at 2 Points and if hit the stop does not move.
The last runner will either be productive or get stopped
out.
If the market pulls back below additional bar delta and
delta at price reviews determine to add or let it stop out.
Initial Risk is 45P [Disaster]. Trade risk is defined by the
chart and adjusted immediately to correct position based
on the chart.
Once established the trade is managed by adding
contracts to existing inventory or reducing inventory as the
trade progress.
 For these 2 traders the view of risk takes on different meanings.

Ross Gary
Holds the view that trade risk has to be small to Holds the view that once the position is established
begin and the first target determines the point to it should be maintained until the market has proven
move to break even. the trade wrong.

Each trade is executed in approximately the same Risk is viewed in segments

fashion with approximately the same risk parameters Account Disaster Risk
Account Trade Risk
The Stop distance will be made wider depending on Account Risk ends at 10P Profit
Volatility. The determination of “Volatility” is an issue Profit risk: any profit over 10P can be used for adds
of experience and not measurement in Ross’s case. Open profit is viewed as risk money
Note: As Ross has many years experience it is highly recommended a new
trader would want to define volatility using ATR or VIX
Adding would be done based on retest of delta at
price.

If the adds bring profit down to 10P trade is closed

and day is completed.
This review of the same trade in the same area by 2 different people has provided an illustration
that the definition of risk varies by the person making the call.

Ross is comfortable looking for additional trades as the market progresses.

This is a personal decision or trading style. Ross feels the style allows for tighter risk controls.
This works beautifully for him; however, it must be noted through the day he is very dedicated to exact
execution requirements.

It must be pointed out that it’s the dedication to specific pattern that controls the risk not the other way around.
You must understand its not a tight stop that reduces his risk. The pattern allows for a tight stop.
Because the trade is defined by specific criteria. Ross knows the exact point where he is wrong.
Gary on the other hand did not learn to trade on a computer. Charts were kept by hand any calculations done
by hand. It was more chart patterns and swing trades. Intraday trading was difficult at best and orders were
placed by phone. Solving these problems required moving into a pit which was a world unto its own. I did learn
how orders flowed through the pit and how size impacted trade. Subsequently I use what I learned over these
years. I have taken the order flow from pit terms and converted it to computer terms. It was the only way I
could see what I used to hear. It took years.

I specifically look for extremes. The large bar delta push and no follow through with a neutral trade area defines
and no positive delta at price in fading session range volume. The risk I take is substantially larger and the
objective is to stay in a good trade location longer, with ability to work that location, all based on the perpetual
reading of trade delta
Ross
Looking for static
support/resistance level in set-up
criteria.
Fading volume, completed auction
and/or buying imbalance. 2 of 3
conditions must be present for
entry.
Gary
Looking for static
support/resistance level in
set-up criteria with an
emphasis on Delta at price
and Total volume at price.
Looking for market data to
display conditions conducive
to range extremes. Once
initiated looks to work the
trade during the life span of
the trade.
Benefits
Since this is known chart
configuration when it does not
exist the trade is invalidated
Benefits
Fading extremes offers the
ability to be in for longer
periods of time. Using
existing profit as risk capital.
Drawbacks
Can disappear quickly.
You must act fast, there is no time
to review.
Drawbacks
Drawdown can be substantial.
A great deal of time can pass
before a trade can be
identified. You can be buying
new lows or selling new highs
all day long with only scalp
rewards
Unknown factors
All that we mentioned in the
beginning apply here. Plus,
environmental conditions. Internet
connections and power
Unknown factors
All that we mentioned in the
beginning apply here. Plus,
environmental conditions.
Internet connections and
power
Largest risk factor
W.A.G. The wild ass guess is the
biggest risk factor. Boredom,
Anxiety, FOMO and Revenge are
all the factors effecting profitability
Largest risk factor
W.A.G. The wild ass guess is
the biggest risk factor.
Boredom, Anxiety, FOMO and
Revenge are all the factors
effecting profitability
Two completely different people working exactly the same trade in the same location and time frame.
Each with their own style but different views on initial risk. The real risk is not where their stop is located,
instead the factors listed here.

Risk Category Solution

1. Internet service Known Have a back up in place. Trade desk phone readily
available. [Printed]
2. Electric service Known Have firms trade desk number readily available.
[Printed]
3. News reports Both: Do not place a trade into news releases and do not
Known/Unknown trade immediately after the news.
4. Twitter, Geopolitical and weather Unknown TRADE WITH STOPS. There is no going back.

5. W.A.G. trades are the biggest immediate risk Known Define your style, test your MAE and MFE, make rules
and don’t violate them.

I hope we can all agree the biggest and most consistent threat to a trader comes from with-in and is
supported through well meaning but misleading information.
 The RISK of computers

The beauty of computers they are binary and the flip side, problems with computer are they are binary.

Your risk is not understanding how the computer adversely affects your performance.

On the plus side we can pretty much define how we want to trade and track that performance.

On the negative side we are limiting the information we need to trade profitably. There are 2 functions
that must be done manually.

To Define your Maximum Adverse Excursion, M.A.E. you must change your trade parameters. The
computer stops MAE tracking when your stop is hit. You will never know if your stop is to tight for your
style.

To Define your Maximum Favorable Excursion, M.F.E. you must change your trade parameters. The
computer stops MFE tracking when your target is hit. You will never know if your target is to far for your
style.
 RISK: The stop might be too tight and always hit or the target too far and never hit,
To test our stops and targets a SIM mode should be used. Every signal your system generates you must
take 1 contract only. The following metrics are to be used for stops and targets. The trade is binary meaning
when you enter you are taken out by the stop or the target. I recommend leaving the office for each trade
to reduce the temptation to fiddle with the trade.
Trade Implied
Stop MAE 80% Target MFE
Price Odds
10 Days 10 9 8 7 6 5 4 3 2 1 1 2 83%
Stop
10 Days 10 9 8 7 6 5 4 3 2 1 1 2 75%
Stop
10 Days 10 9 8 7 6 5 4 3 2 1 1 2 3 67%
Stop
10 Days 10 9 8 7 6 5 4 3 2 1 1 2 3 4 60%

Stop Location 80% of profitable trade draw down. Profit Target

This test allows us to determine what Stop size fits our trade methodology and what Target is least productive.

Slide the orders in this direction

There are many faces to Risk in the trading business
Don’t be a statistic
1. Your style does not fit your account.
2. Stop and target locations incompatible with your style. Every trader picks the pain they
3. Weather. choose to live with.
4. Utility: Internet service, Electric.
5. Social media: Twitter. 1, The pain of discipline
6. Geopolitical. 2. The pain of regret
7. News: Both scheduled and random.
8. Expectations are incompatible with capabilities. Regret last forever

These hedge funds do not exist anymore. Hundreds of million to

Billions was lost leading to their collapse. The primary cause was
failure to use correct RISK management practices.

1. Tiger Funds
2. Amaranth Advisors
3. Aman Capital
4. Marin Capital
5. Bailey Coates Cromwell Fund