Money Management  |  NOV 2006

Measuring Risk by Lee Leibfarth

Stocks & Commodities V. 24:11 (20-26): Measuring Risk by Lee Leibfarth The most important concept in building a profitable trading system is to protect your capital. Here’s a look at some of the techniques you can apply to measure your risks. Would you consider riding a roller-coaster at an amusement park? How about tak-ing a whitewater rafting trip or climbing Mt. Everest? For everyone the answer will be different, as we each assess risk and reward differently. Herein lies the reason why one style of trading doesn’t work for everyone: as traders, we all have different risk tolerances. This article will discuss some methods of measuring risk and explain some of the basic principles of successful risk management. DEFINING RISK In the context of trading, risk refers to the probability of losing money or trading capital. The primary goal of trading is to protect capital. This is, by far, the most important concept in building a profitable trading system. While it may seem that the first goal should be to make a profit, simply focusing on profits (or returns) may cause traders to take unnecessary risks, causing them to burn through a trading account. The fact is, without enough money, traders are bankrupt. Game over. Once a trading account has been lost or severely depleted, it can take a long time and a lot of stress to start over. Proper planning and money management allow traders to establish systems that will protect their most valuable asset: trading capital.

by Lee Leibfarth