Risk Management in Trading by Mobirao

Risk Management in Trading

This Book Includes:

OVERVIEW OF BOOK

This book describes how risk management techniques are used by professional traders to reduce risk and maximize profits. The focus of the book
is how traders working at hedge funds or on investment bank proprietary
trading desks use risk management techniques to improve their profitability
and keep themselves in business. However, these techniques can be applied
to almost any trading or investment group.
This book focuses on six major activities that are part of managing trading businesses.

Topics Covered

• 1. Backtesting and Trade Forensics. Backtesting is a disciplined approach to testing trading ideas before making bets with actual money. Trade forensics is a post‐mortem analysis that identifies how well a trade is tracking pre-trade predictions and if markets have changed since the trade was initiated.
• 2. Calculating Profits and Losses. Once a trade has been made, traders have to calculate the daily profits and losses. For some financial instruments, this is as simple as checking the last traded price from an exchange feed. For other investments, calculating the fair value of the trade is challenging.
• 3. Setting Position Limits. The size of investments that traders can make is typically limited by the volatility of their expected daily profits and losses. In other words, risk can be a way to measure size. As a result, the goal of hedge fund traders is to maximize profits relative to a fixed amount of risk.
• 4. Hedging. Hedging is a trading strategy designed to limit profits and losses in one investment by taking an offsetting position in another asset. For example, a hedge fund might want to lock in profits associated with a physical asset like an oil well that it can’t sell right away. They can agree to sell oil at a fixed price and remove the risk of price fluctuations.
• 5. Managing Option Risk. Certain types of financial instruments, particularly options, present much more complicated risk management challenges for traders. Risk managers have developed a variety of techniques to model this risk and fit options risk with other position limits.
• 6. Managing Credit Risk. Trading can’t be done in isolation. Every time someone wants to buy an asset, someone else needs to sell it. Not all trades settle right away—trading often involves obligations that are taken on in the future. As a result, traders depend on their trading partners to meet their trading obligations and are exposed to the risk that their trading partners will default on their obligations.

TRADING DESKS

Professional traders often work on teams called trading desks. A trading desk is a group whose members are traditionally seated side‐by‐side at a series of long desks (usually filled with computer equipment) that is responsible for buying and selling financial products for an organization. Trading desks will typically specialize in one or two types of financial products. Some trading desks will specialize in stocks, others in bonds, and so on.

Many types of companies will maintain trading desks. Some of these desks will focus on supporting the company’s other lines of business— buying fuel for a trucking company or financial products on behalf of investors, for example. However, a couple of types of trading desks are operated as their own line of business.

The most prominent of these are mutual funds, hedge funds, and proprietary trading desks at banks.

Price Action by Mobirao

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