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Risk Control In the Stockmarket

Discussion in 'Shares' started by wdongli, 22nd Nov, 2010.

  1. wdongli

    wdongli Well-Known Member

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    IT busts and GFC sucked huge amount of money and forced millions, if not billions, of people burnt the money on the fire. It shows some affordable risks each of us have to concern very seriously.

    What do you think about this subject and do you prepare to put risk/opportunities and your deep understanding on them into your market practice. There are a lot of Great Investors and Wise Speculators who take the core of them and get great successes.

    We need to rethink about them and find the chances for the opportunities in the market with little risks to our hard-earned capital first if we could not get NO LOSS as Warren Buffett rules of investment highlight.

    It is a topic since human started to appear in the global I believe to take the affordable risks for surprised quick or huge profit. Please note no any profit could be got easily for a long enough time if you stay in the market. Actually making money should be simple logically. However to make the simple money always require hard work physically or mentally.

    I would put my learning, thought, and the plan to take the risks for profit in my blog of InvestEd. So if you are interested and have any great ideas to help me develop the knowledge bases and skills to get a correct strategy, plan, and actions in the market to deal with the risks and opportunities, you are welcome to drop down some gems in my blog.

    Thank you in advance.
     
  2. Johny_come_lately

    Johny_come_lately Well-Known Member

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    What do we really know about risk? A Black Swan event always catches everybody off guard!





    Johny.
     
  3. wdongli

    wdongli Well-Known Member

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    GFC shows most of market players don't understand the risks and how to deal with the uncertainties. We tend to ignore the risks and the possible damages in worst case when everything looks OK and fear to burn the money on fire.

    Too many of us get used to the peaceful social life. Don't know the market naturally is cyclical one. The bear follows the bull to destruct the asset and money and the bull follow the bear to roar.

    A Black Swan is viewed as the rare, improbable, and once occurs it would shock and surprise the market negatively or positively. How to identify the best and sell to collect the money from the table and how to identify the worst and buy in to get the position for the least cost?

    It is challenge to harness our herd nature if we really want to win in the market. We need to spend the time and efforts to know the risks, the uncertainties, the frequency of the crisis, the market sentiment in worst and best.

    We all know "buying when the Wall Street is full of blood and selling when the Wall Street makes money for both of the genius and bums." It is a matter easy to know but hard to implement since naturally we are not different from the human herd.

    We need to turn a lot of Unknown to Known about risks and uncertainties and then we could have cool mind when the air is extremely hot and warm head when the herd is in the cold water.

    I would put half year or maybe more to learn and study the risks and uncertainty. A fire player have to know the fire first and then we could get the butters from the fire.
     
  4. Johny_come_lately

    Johny_come_lately Well-Known Member

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    Many years ago, when I met my first financial advisor, he gave me a questionare. After answering 10 questions, he informed me I was an aggressive investor. He didn't stress test me. He didn't tell me I could lose half my money. Those 10 stupid questions cost me bigtime. I am happier now to get 7.2% av. with low risk, than 10% av. with high risk. Just because high risk makes me more money, doesn't mean my financial plan needs high risk.



    Johny.
     
  5. wdongli

    wdongli Well-Known Member

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    Hi Johny, I mainly buy and sell pennies mainly because they could provide quite good leverage if I am right. I usually buy them in group at the price I believe are lowest to get some big puffs from the Cigar butts.

    I started to play the pennies at 2004 after sucking up the cuts and bloods in IT bust and started to put geared money into the fund at 2006. The professionals of my funds have lost half of my capital in GFC but fortunately I have got some profit more than 30% sometimes more than double profit from my penny share portfolio per year. I bought aggressively between Nov 2008 - 2009 which set the base for me to double my capital from the GFC ruins.

    Logically I prefer W. Buffett's words, when the market is greedy we should be fearful and when the market is fearful we should be greedy. I feel we need to know the worst and best, buy in worst in diversification and keep enough cash to avoid sale on fire.

    Risk and uncertainties as anything in our life could mean the opportunities or the slaughter table setup by Mr. Market. We need good true knowledge about risks and uncertainties and get the vision to turn the high-risk-high-consequence matters into no-risk-high-consequence ones. We have to positively answer the questions: could we buy in worst for lowest price? Could we sell in the mania for good enough? How could we never let enoughness of profit turn into zero or worst? how could we still ok if some of our capital is trapped in the worst or drop into hell?...

    I quit my job through voluntary redundancy in July 2009 since I didn't want to scale down my salary and the return from my property investment(bought in 1994/1995 and still hold) surprised me. I want to deal with the market playing as my business and try all to get through the first 2-3 years with good enough profit. I really want to accumulate enough money before my 70s to let me no worry to dream(17 years away). Don't want to live just on the Senior Pension to end my life.
     
  6. JPM Group

    JPM Group Member

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    Johnny, as a financial planner you are right. The financial planning industry is a joke not only how they determine the clients attitude to risk but the multi-layering of fees attributed in the industry to run super and investment portfolios.

    What you need to look at is the fundamentals of the global economy and how this impact asset classes. Currently the continued push of Quantative Easing by the US is only going to prolong the pain. In addition, a very simple indicator is the demographic trends. As humans we reach our peak consumption at age 47, as this is the age where households consume the most for themselves and their dependent children. Through the period 2002-7, access of credit even fuelled the consumption and drove business earnings and profits up and therefore reflective in share price increases. Now as people are saving more, spending less and credit is harder to get this will impact earnings for companies.

    A defensive portfolio is highly recommended at this point in time, still have some exposure but select companies with strong balance sheets, good operating cash flow and paying above average dividends. In addition China demographic trends will peak in 2014, and then their one child policy really kicks in. As the US continue to print money, holding some hard asset exposure (i.e. commodities) is essential and something to look at.

    At the end of the day you must feel comfortable with what you or your advisor is putting you into. Do some research on the global economy, look at biggest attributers to world growth and the 4 biggest are US, Europe, Japan and China. The first 3 are in trouble (big trouble) and China is the only economy holding this up (but wont last too long) with the demographic trend point down post 2014.

    And with knowledge, I can guarantee you will make your financial advisor look silly. They will continue to sell you the long term strategy, ensure you diversify your portfolio and can only push you into platforms/managed funds that you will get charged with multi-layering of fees (i.e. MER, administration fees and adviser fees).

    Take control and learn - you will really enjoy the dynamics of the global economy and you will soon starting understanding the risk and this impacts asset prices.

    Hope this helps.
     
  7. Tropo

    Tropo Well-Known Member

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    There are few different types of risks:

    - avoidable risk (eg...trading illiquid shares/markets),
    - controllable risk - risk that can be determined before a trade is initiated (stop loss methodology),
    - uncontrollable risk which cannot be determined ( war, volcano eruption on Wall Street etc...).
    There is a practical way to estimate the risk if you employ the concept of drawdown and max drawdown.
    Drawdown is the amount of money going into or out of an account (kind of cash flow analysis when reviewing winning/loosing trades).
    Max drawdown provides the trader/investor with an idea of how much might be lost in a series of bad trades.
    Slippage risk.

    Risk and Reward.
    Every trade should be evaluated on the basis of risk versus reward (money management quantify this relationship).
    Risk reward of 1:3 means that risking a $1 aim is to make $3.
    Risk is a probability of a loss based on single adverse event or string of events.
    Rewards is a probability of a single/string positive outcomes.
    Reward does not increase with time, but risk does.
    Reward is a function of the timing of entry and exit...as opposed to the length of time position is hold.

    Stop Loss is a must (to avoid catastrophic losses).
    2% stop loss = Do not risk more than 2% of total capital you trade on any one/individual trade.
    Using 2% stop loss you might survive long streak of losses (100+ loses based on $50K capital).
    It is much easier to recover from losing 10% of your capital in a sequence of 2% losses than it is to recover from a string of 10 losses of 10% each.

    Sad truth about trading/investing is that a 10% loss cannot be made up by a 10% gain.
    So, if you had $10K to trade and you lost 10% or $1000 leaving you with $9000.
    A 10% gain on $9000 is $9900.
    You need an 11.1% gain to breakeven.
    So - losing say ... 50% required 100% gain to breakeven.
    Below equation summarised this statement:
    G=L/(1-L)
    G=gain required to recoup loss
    L=% loss incurred.

    A lot of investors/traders ignore position size (how much money is placed in a trade).
    Below example determines position size if risking a certain % of the available equity (2%).
    We are trading with say ... $50K capital using 2% stop loss.
    Say... we bought XYZ at $17 and stop loss is set at $15.
    Potential loss per share = $2 (and 2% of $50K = $1000)
    Max. amount of shares we can buy = 500 shares (1000 div. by $2).
    Position size = $8500 (500 shares x $17).

    Diversification = "Diversification is a hedge for the ignorant" - W. O'Neil
    If one does not have a method to trade one stock right, how one can get 5 or more right?
    To control risk in the markets all comes down to have a tested, proven system and correct risk/money management rules in place. :cool:
     
  8. wdongli

    wdongli Well-Known Member

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    All of us unfortunately start the market playing as idiots without recognition of our own ignorance. Before we give up or could be reborn in the market by designing, testing, and confirm we have a trustful mental system, we don't know we need to be conservative on our betting.

    Diversification, time averaging the risks, loss cutting, reduction of the productive costs to buy in the mess of the burnt money, management of the opportunity costs, enough cash reservation to avoid fire sale, collection of the profit when the market as a whole is in mania to wait for the crash, and so on are parts of an effective risk management system. It is challenge to put all of them into a box and let them work smoothly and balanced in timely way based on the environment changes.

    Risk management on the earth is to survive first and thrive second.

    It is true in war, if you could not protect yourself you would not kill your enemies in fighting; if you could not kill your enemies you would lose the chances to protect yourself.

    It is true in Business if you could not get the moat to get good enough monopoly in your circle you could not survive; if you don't get the competitive advantage, your moat would be destructed.

    It is true to the market players, if you don't have the enough protection, next GFC would kill you financially; if you just are too conservative to risk dollars for pennies, once Mr. Market drag you onto the slaughter table, your dollars would be gone.

    Just wonder if we could not have a plan to get $10,000,000, how could we get our moat strong enough and get the opportunities? Since if you could win $10,000 the way to get it should be the same as you get $10,000,000.

    We seem need to think openly, greatly, delightfully, unlimitely first about the risks. No loss and we have the plan and then we just need to worry how much we really want to get!