Trading Through the Eyes of a Risk Manager

05/27/2010 12:01 am EST


Michael Toma

Author, The Risk of Trading: Mastering the Most Important Element of Financial Speculati

I always look forward to the Traders Expo events throughout the year. It gives me a wonderful opportunity to step away from the trading desk, recharge the batteries, and talk with my peers in this fascinating business. The most valuable experience, however, is listening to traders seeking that climb towards the professional level. I’m looking forward to meeting you in Pasadena in a few weeks!

One of those encounters was at the most recent Expo in New York, where I shared my trading plan, key performance reports, and development plan highlights with a passionate, up-and-coming trader. He first came up to me and wanted to ask if I had a setup he could use. “Business plan, development plans, reporting…that's a lot of work. All I need is one good setup, Mike!” in the same tone as if he was asking for the winning horse three minutes prior to post time. I told him that setups are the least of the challenges in this business. It starts with the core foundation of why we trade and what we want to accomplish in this profession.

His eyebrows were raised as if a mouse was discreetly hopping on my shoulders, but he gave me the floor with a hesitant gesture to proceed with my anticipated boring trader psychology lesson. We discussed the importance of the “Big Four” tools of trading: Bankroll, knowledge, risk management, and discipline. Although he told me he was struggling as a trader, he continues his effort to move the conversation towards setups. “I have money, know what I’m doing, and I use stops.”

Knowing I had my work cut out for me, we ordered a decaf and probed the other requirements for success, the “Little Three:” Accountability, execution, and consistency. While its my goal to detect areas of development in all seven elements, we focused on discipline and consistency, and he agreed that a good setup is meaningless if you cannot trade it according to a set of valid rules with consistency.

While he was eager to hear my advice, he was taken back a bit by my answer. I told him that if he wants to be successful in trading, the first thing he’d have to do is to start treating it like a business. “Stop looking outward for that one key to success. Look in the mirror and be committed to master the core elements of the Big Four/Little Three first, and then we can talk about setups.”

The first thing I recommended was to stop thinking of himself as a trader, or one who simply trades. Executing trades is important, but only after you have a solid foundation. I wanted him to start thinking like a risk manager; not a trader.

While I am a full-time professional futures trader, my core experience and credentials are that of a risk manager. I still use my risk management reporting templates from my corporate days when completing my risk assessments, trade journal analytics, and reporting. I urged him to develop an audit-like mentality about this business.

Risk managers are like auditors; always trying to find what can possibly go wrong. We never first focus on how much we can make on a trade; only on the risk of what we can lose. We understand that this is a numbers game, similar to how a casino makes money. We are extremely data-driven and base all of our decisions on a valid sample of historical data. We thrive and seek edge—advantages and probabilities that historically put the odds in our favor.

Like a pendulum that occasionally swings too far, I only want to play a game like blackjack when I am dealt a twenty and the dealer has a six. Sure, every so often the dealer will beat me or pull out a push, but wouldn’t it be great to play the game only when that occurs? The beauty about the markets is that you can. If you told the casino that you only want to play when you have an edge, you would be kindly escorted out the door, or at least invited to play the slot machines, where the casino controls that very same type of edge we are allowed to play in the markets. The market will reward over time if you consistently take advantage of probabilities, not possibilities, and execute consistently without emotion or hesitancy. Simply put, quit being a trader per se and start being a project manager—one who’s responsibility is to merely execute a valid plan that takes advantage of historical probability.

This is all I do every day for a living; nothing more, nothing less. My goals are to execute my plan with precision and continue to focus on the developmental areas where my data-driven statistics are telling me I need to improve. I had an excellent coach when I first started trading, but now, my best coach is my trade journal data.

When asked what I do for a living, I often say I am a risk manager, just like in my prior corporate role. In a way, nothing has changed from that role but the venue. I often tell others that I am an average trader, but I can manage risk well, can identify edge and value, and execute a plan that incorporates these principles with relative consistency. Conversely, my track record is 50% at best regarding where I think the market is heading.

It’s easier said than done to truly perform tactician-like, emotionless trading. But when asked what was my “light-bulb moment” in this business, it was when I decided to not care about trying to beat the markets or think about the money. I focused all my efforts on just implementing a plan that historically has provided me with an edge and to enter at an optimal price level, allowing me to meet my strict risk management rules. In many trades, I do not know where I’m ultimately right, but I always know when I’m wrong. In my mind, the outcome on any trade is really not important to me anymore. I know if I execute my plan without emotion over a valid sample of trades, I should come out on top. That means acceptance of losing trades too; sometimes several times in a row. Losing is only a concern if I break my plan rules. Otherwise, losing trades occurring within the randomness of markets are viewed as part of the success formula.

I told my new friend that teaching setups, market dynamics, and charting can be taught in a relatively short period of time. It’s mastery of managing risk and learning to perform risk analytics using data driven audit standards that can consume a trader during the learning curve. Translating what your trade data is telling you is an important piece in ones development and ultimate success. Learning as a way of life has always been one of my core principles as a trader, risk manager, and coach. I’m continuously learning from speakers at the Expo, talking to the attendees, and listening to the loudest voice of all, my trade journal data.

By Mike Toma

Mike Toma can be found at Mike will be speaking at the upcoming Traders Expo in Pasadena.

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