$$ Managing Risk

Lessons from Jack Schwager's Market Wizard series:

Paul Tudor Jones

"Never play macho man with the market. My major problem was that I was trading far too many contracts relative to the equity in the accounts I handled. My accounts lost something like 60 to 70% of their equity in a single trade.

Risk control is the most important thing in trading. My guiding philosophy is playing great defense, not great offense. Now, I want to make sure I never have a 10% loss in any month."

Bruce Kovner

"Risk management is the most important thing to understand. Whatever you think your position should be, cut it in half. My experience with novice traders is that they trade 5 times too big. They are taking 5-10% risks on a trade when they should be risking 1-2%.

A greedy trader always blows out. I know some really inspired traders who never seemed to keep the money they made. One always struck me as a brilliant trader. Intellectually, he knew the markets better than I did, yet I was keeping money and he was not. Where was he going wrong? Position size. He traded much too big. For every one contract I traded, he traded ten. He would double his money on two separate occasions each year, but still end up flat."

Ed Seykota

"The three elements of good trading are: (1) cutting losses, (2) cutting losses, and (3) cutting losses. Keep bets small."

Larry Hite

"The very first rule we live by is: Never risk more than 1% of total equity on any trade. Keeping risk small and constant is absolutely critical. For example, one manager I know had a large account withdraw half the money in the account. Instead of cutting his position size in half, the manager kept trading the same number of contracts. Eventually, half the original money became 10% of the original money. Risk is a no-fooling around game; it does not allow for mistakes. If you do not manage risk, eventually they will carry you out."

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I define risk (R) as the amount of money I will lose if a trade goes against me and I get stopped out. I accept the fact that: 1) there will often be slippage with stop-market orders, and 2) occasionally price will gap through my stop.

Currently, R is a standard sum less than 1% of account value. I risk the same amount of money on each trade.