Written exclusively for TickerTank by Mike Kingery
Risk in trading should and can be examined by different means, some of which follow.
Period of Exposure
All things else being equal, the risk of a trade is proportional to the amount of time that one is in the trade. The shorter the time exposure is, the smaller the effective risk. Day trading futures is a good case to illustrate this. Commonly, futures trades are just minutes in duration, from open to close. In general, few go longer than a day. Lack of market exposure makes for a good night’s sleep. At the other end of the scale, consider the exposure period of a trader (investor) having a buy-and-hold position in a stock or ETF. If the answer to the question, “hold until when?” is left open, go figure. Not only is the trade risk high, the exposure period is virtually infinite.
Probability of a Loss Event
The period of quarterly earnings announcements has more risk associated with it
than “normal” periods. The presence of other activities affecting market sentiment (e.g.
FOB meetings, announcements) increases risk. The current debate about U.S. debt limit
is a perfect example of government political antics affecting trading risk.
Knowledge & Competency of the Trader
I believe that a novice traders’ risk exposure is greater than more experienced traders.
And from personal experience, I’m of the opinion that a novice trader tends to
overestimate his trading readiness and proficiency. Depending on the individual, it
can take some time for this to be corrected. Sometimes, the trader goes broke before
his enlightenment comes. Interestingly, this effect is present even in novice traders that
consciously prepare themselves by education and training. The brokers apparently
agree, because I believe that brokers routinely assess client trading activity and reach
their own conclusion as to what “class” a trader belongs in. I’m told that Classes
range from 1 to 5, with Class 5 having the greatest trade proficiency. A ‘5’ being the
top. To my knowledge, the traders’ Class is not indicated anywhere in the account.
The trader usually can sense which Class he is in by considering the buying power
reduction assigned by the broker to his trades, or in the extreme outright order rejection. A trader with a Class less than about 3 would be discouraged from selling naked puts, for example.
One needs to be conscious of the fact that ones’ personality affects trading performance. A trader experiencing anxiety of any sort can be expected to perform badly. Medical situations, family concerns, other environmental situations interfere with the process and affect the outcome. This is a complex subject, requiring a lot of introspection. In my opinion, ignoring it is not an option.
Consideration of risk should never be far from mind.