The Ultimate Risk Management Tool: Equivalent Risk (Part 5)

07/16/2010 9:32 am EST

Focus: STRATEGIES

Timothy Morge

President, MarketGeometry.com

(Continued from Part 4)

Are there other ways to measure the risk of an instrument? Yes. This is meant as a beginning example and is actually quite useful, as simplistic as it is, but feel free to explore and use other measures of risk or volatility.

Now let's build a table around this standard risk measurement and see if we can work our way to actual equivalent risks across these instruments.

chart
Click to Enlarge

By using the standard risk measurement, we are now able to use a simple formulae to come up with similar or “equivalent risks” when taking positions in any of these instruments. This table assumes that the standard position used to determine the position size in any of the other instruments is based on 10,000 shares of Apple, but you could easily change the number of shares or even change the standard from Apple Computer to any instrument (for example, I use US 30-day Treasury bills as my standard unit and compare the riskiness of all other instruments to 30-day T-bills).

Note that I purposely shared the Excel formulas when making calculations; and as I have said several times, this worksheet is meant as a starting point for each of you. To get a real feel for the relatively volatility of the instruments you trade, I urge you to re-create this spreadsheet with the instruments you actually trade, or you can simply use the instruments I have used and practice your Excel skills. But if you have the ability to get the current 20-day ATR for each instrument, when you create your own copy, use the current ATR and don't forget to use your own maximum stop loss sizes!

I hope you find this exercise interesting. Many of you may have never thought of looking at your position sizes using this type of tool, so give it a try! Some of you may have better tools for comparing the volatility of instruments. If so, please feel free to drop me an e-mail and share your thoughts, questions, and criticisms.

By Tim Morge, veteran trader and trading mentor, MarketGeometry.com

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