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How do you define risk?

  • #21
  • Jul 18, 2005 9:02am Jul 18, 2005 9:02am
Quoting fijitrader
The key word is "imply". Volitility itself does not imply risk any more than when I stand on the shore and watch 10 meter waves come in or when I stand on the shore and watch 1 meter waves come in. Either way I don't experience increased risk unless I get too close to the action.

However when we define what our relationship is with the volitility then we can create situations where risk increases and decreases relative to our trading parameters.

...

There are so many ways to look at risk but the real answer is that risk is always relative to other objectives and does not exist on its own. Increased volatility implies no risk to someone who is not in the market. [emphasis added by Redleg]

FT
Hi FT,

This is an excellent point. The first step to meaningfully comparing the risk between two systems is to define your objectives - what you are trying to accomplish. Risk only exists within a context.

Good food for thought on slippage - I don't tend to worry about slippage that much ... perhaps because I've only traded forex. But I can see where slippage could pose a significant risk.

Quoting fijitrader
Increased volatility implies an increased probability of a stop being hit but it also implies an increased probability of a target being hit. Therefore your risk and reward both increase with an increase in volatility so the question about whether risk increases would be more complex and not related so much to volatilty itself. All things being equal risk does not increase in that situation if volatility and liquidity remain in proportion and do not threaten your chances of exiting according to your risk parameters. Risk does not increase with volatilty if you can be sure your exit is going to happen where you define it.
This is exactly why it bugs me when people equate risk with volatility, or assume that increased volatility results in increased risk. It's not that simple, and the inverse relationship may even be true under certain circumstances.

Thanks!

James
  • #22
  • Jul 18, 2005 9:06am Jul 18, 2005 9:06am
Quoting fijitrader
Probably the greatest risk and hardest to quantify when comparing one trading system over another is the traders propensity to interfere with the system. A system that is not well suited to a trader will represent the greatest account risk whereas a system that is well suited to the traders psychology will represent the least risk.... assuming the systems are both winning systems.

FT
Agreed. Although getting a feel for this seems to become easier very quickly the more systems that I try.

James
  • #23
  • Jul 18, 2005 9:18am Jul 18, 2005 9:18am
Quoting meedo29
from my humble point of view, I think that the trading method has a wider meaning other than comparing trading systems...

For example, a trader who trades the news suffers much higher risk than another trader who only trades quiet markets, even if they use the same trading system...
Definitely true. I think it is more difficult to meaningfully compare risk for systems that use different general trading methods than for two systems that use basically the same trading method. Everything would be relative to your objectives.

On the other hand, if you trade a portfolio of systems and want to reduce your risk by diversifying - then different trading methods would be a far more meaningful way to diversify than multiple systems with the same general approach to the markets.

Quoting meedo29
I think it's very obvious that risk is equated with volatility, even though profit also is equated with volatility...
If you define risk as the probability that your stop loss will be hit, then this is true. But if you define risk as the probability that your system will fail, then it's entirely possible that risk would decrease as volatility increases. At least up to a point.

Thanks!

James
  • #24
  • Jul 18, 2005 9:28am Jul 18, 2005 9:28am
Quoting narafa
In the options/futures markets, which I consider the hardest ones to trade, when volatility increases, you would expect gaps, runaways, and all the wild price actions that you can expect. Unlike the forex market, where gaps are limited to week openings, stops in the options/futures markets are not gauranteed, and with volatility increasing, you might expect to lose or win more than your loss/profit target by several points. This is not considered slippage, but is considered more risk and more reward over an open trade.

Increased volatility means nothing to someone on the sidelines who is not willing to enter the market, but means a lot to someone who is watching to enter. It must affect the price you will enter at, it affects the whole view about the trade itself, it affects the stop/limit targets, everything is affected only if you are looking to enter the market.

As FT said, liquidity plays an extremely important role. Usually, volatility increases due to the increase in liquidity, but not in all times.

Another thing to note is that there are 2 types of volatility:

1- Historical Volatility
2- Implied Volatility



Historical Volatility reflects the past price movements of the underlying asset, while Implied Volatility is a measure of market expectations regarding the asset's future volatility.


Implied volatility is much more important than the historical one, because it aims at antcipating the future volatility. The implied volatility is mainly calculated based on the behavior of the options prices.

Another good measure used in stocks is the beta, which is a risk factor comupted by measuring how volatile a particular stock is relative to the general market.

A beta of 1, means that the stock is of the same volatility as the general market.

A beta of 0.5, means that the stock is half the volatility of the general market.

And a beta of 3, means that the stock is 3 times the volatility of the general market.

The beta is usually considered a risk measure as it increases, the risk increases, but that's only for the historic data.

Since the forex market has no general market, the beta can't be calculated using the same way. I have been searching for a method to calculate a beta for a certain pair, but all my attempts failed till now.




Hi Narafa,

Can you elaborate on the differences between historical and implied volatility? Are both of them some function of standard deviation? What is different about the way that they are calculated?

On measuring beta for forex - on netdania free charts there is something called the "US Dollar Index." Would you be able to produce something like beta if you compared US based currency pairs to the US Dollar Index?

Thanks!

James
  • #25
  • Jul 20, 2005 6:29am Jul 20, 2005 6:29am
Quoting Redleg
Agreed. Although getting a feel for this seems to become easier very quickly the more systems that I try.

James
I was only talking about risk in that comment. The point remains that if you look at a system that is not suited for you it represents a higher risk than one that is. There are always systems out there that you could never make your own no matter how hard you try. They will always represent a greater risk to you than to someone whose personality they fit. Especially long term. Van Tharpe claims that the ONE thing all great traders have is a system or systems that suit them. So perhaps that is the greatest risk factor of all... not having a system that suits you.

FT
  • #26
  • Edited 3:25pm Jul 30, 2005 3:14pm | Edited 3:25pm
Quoting Redleg
Hi Narafa,

Can you elaborate on the differences between historical and implied volatility? Are both of them some function of standard deviation? What is different about the way that they are calculated?

On measuring beta for forex - on netdania free charts there is something called the "US Dollar Index." Would you be able to produce something like beta if you compared US based currency pairs to the US Dollar Index?

Thanks!

James

Sorry for being late in the reply,

Investopedia.com offers a very good explanation for the three terms, Volatility, Implied Volatility and Historical Volatility.

You can find those definitions throught the following 3 links:

http://www.investopedia.com/terms/v/volatility.asp

http://www.investopedia.com/terms/i/iv.asp

http://www.investopedia.com/terms/h/hv.asp


I must admitt that they explain it much more better than I would explain it but trying to tell a word of mine, implied volatility EXPECTS the future volatility or tries to, and historical volatility only measures the historic volatility of a certain security.

You will find a confusing statement in the definition of the implied volatility which says that implied volatility tends to increase with bearish markets and decrease with bullish markets due to a preception that bear markets carry more risk than bull markets.

In forex, and since currencies trade in pairs, both bull and bear markets occur with any move. An advance in one currency dictates a decline in the other, so one of them is in a bull move and the other is in a bear move, so you will find the statement apparently not applicable to the forex.

However, this is incorrect. The EUR/USD is traded all over the world with the same direction. It is always EUR/USD and not USD/EUR. So people always look at the pair and say we are in a Euro bull market or we are in a Euro bear market. So the perception is the same. When the Euro is falling and the USD is advancing, the moves tend to be sharper and stronger, supporting the concept that the implied volatility increase in this case, while the opposite is true as well when the Euro is advancing and the USD is falling, the implied volatility decreases.

Usually traders get nervous when they see the chart falling and act wildly, while they act with more cautious if they see the chart rising, that's why I believe that taking short positions is better and can be more profitable than long ones.

Thanks,

Nader.
  • #27
  • Jul 30, 2005 10:11pm Jul 30, 2005 10:11pm
Quoting narafa
Sorry for being late in the reply,

Investopedia.com offers a very good explanation for the three terms, Volatility, Implied Volatility and Historical Volatility.

You can find those definitions throught the following 3 links:

http://www.investopedia.com/terms/v/volatility.asp

http://www.investopedia.com/terms/i/iv.asp

http://www.investopedia.com/terms/h/hv.asp


I must admitt that they explain it much more better than I would explain it but trying to tell a word of mine, implied volatility EXPECTS the future volatility or tries to, and historical volatility only measures the historic volatility of a certain security.

You will find a confusing statement in the definition of the implied volatility which says that implied volatility tends to increase with bearish markets and decrease with bullish markets due to a preception that bear markets carry more risk than bull markets.

In forex, and since currencies trade in pairs, both bull and bear markets occur with any move. An advance in one currency dictates a decline in the other, so one of them is in a bull move and the other is in a bear move, so you will find the statement apparently not applicable to the forex.

However, this is incorrect. The EUR/USD is traded all over the world with the same direction. It is always EUR/USD and not USD/EUR. So people always look at the pair and say we are in a Euro bull market or we are in a Euro bear market. So the perception is the same. When the Euro is falling and the USD is advancing, the moves tend to be sharper and stronger, supporting the concept that the implied volatility increase in this case, while the opposite is true as well when the Euro is advancing and the USD is falling, the implied volatility decreases.

Usually traders get nervous when they see the chart falling and act wildly, while they act with more cautious if they see the chart rising, that's why I believe that taking short positions is better and can be more profitable than long ones.

Thanks,

Nader.
Nader,

Thanks! Looks like those definitions might be a part of options pricing theory. I'm going to have to read up on that one of these days.

Interesting analysis of long/short tendencies in EURUSD. I had not heard that angle before.

James
  • #28
  • Jul 31, 2005 7:29am Jul 31, 2005 7:29am
Quoting Redleg
Nader,

Thanks! Looks like those definitions might be a part of options pricing theory. I'm going to have to read up on that one of these days.

Interesting analysis of long/short tendencies in EURUSD. I had not heard that angle before.

James
Well yes, the volatility measure is more important in the options pricing since options fluctuate in value before expiring, so volatility is very important prior to expiration.

Implied volatility is more important for assessing if the options are fairly, over or under priced.

And regarding the long/short analysis in the EUR/USD, this was just an opinion, it could be correct and could be wrong. But that's what I believe

Thanks,

Nader.
  • #29
  • Jul 31, 2005 7:52pm Jul 31, 2005 7:52pm
Quoting narafa
And regarding the long/short analysis in the EUR/USD, this was just an opinion, it could be correct and could be wrong. But that's what I believe
If you believe this you must have some research or data to back it up?

Personally I've never noticed a tendency for the EURO or any other currency to break harder, farther or faster in one direction than the other at least as a generalization. Of course there have always been points during various phases of trend development where I've noticed it breaking harder to the downside or the upside... primarily during reversals where it shoots up or down rather dramatically. The euro from it's launch in 1999 around 1.75 was in a major down trend till around 2000 where it bottomed around 1.81 or so and then its launch into becoming a public currency in 2002 around .90 had already begun a major up trend that saw no major interruption till late 2004. Then there were all kinds of minor trends. But since a floating currencies value does not really have a floor or ceiling other than the temporary points of support and resistance what information or data do you use to back up your belief?

FT
  • #30
  • Aug 3, 2005 4:19pm Aug 3, 2005 4:19pm
Well FT,

I based this conclusion on pure pshycology of traders, nothing more and nothing less. I haven't researched this matter deeply, but I believe that it will be true if deep analysis is done on historical data.

I have to admitt that I need to study the historical data in much depth to support my point of view, but I have seen this before in stocks during the 2000, 2001, 2002 US bear market.

Given the difference between stocks and currencies, I think I will have to go back to the history of currencies and study this point of view to see if the past supports this opinion or not.

Thanks,

Nader.
  • #31
  • Aug 3, 2005 4:38pm Aug 3, 2005 4:38pm
Quoting narafa
Well FT,

I based this conclusion on pure pshycology of traders, nothing more and nothing less. I haven't researched this matter deeply, but I believe that it will be true if deep analysis is done on historical data.

I have to admitt that I need to study the historical data in much depth to support my point of view, but I have seen this before in stocks during the 2000, 2001, 2002 US bear market.

Given the difference between stocks and currencies, I think I will have to go back to the history of currencies and study this point of view to see if the past supports this opinion or not.

Thanks,

Nader.
Psychology for trading Equities are so much different than currencies that I'd be suprised to find the psychology even remotely similar. Merlin has probably already done the research on this since he has already determined that there is no notable difference in the frequency of breakouts to the upside or the downside in currencies. Probably he has also determined if there is statistical evidence to support whether there is greater historical risk to the down side or up.

I think if Merlins argument that he doesn't believe that traders see a greater risk on one side of the market than the other probably stands a greater chance of holding true with the Forex markets than any. The traders that play a large enough hand to move a currency pair are not likely to stay in the game to continue playing those size trades if they have a greater fear of being long than short. Equites are so different that you can hardly even treat them as one market. Some are so thinly traded they are not even touched by institutional money. Others are so liquid and traded by so many professionals that they behave completely different. Some equites are in sectors that behave completely different from other sectors. Equities can actually cease to exist and if they sell off too much can take years to recover. Currencies and commodities will always be there. There are much higher ratios of buy and hold investors in equities whereas this notion has an entirely different psychology in currencies. Therefore I find it difficult to apply any psychology to a currency pair that I've gained from equties. The same holds true with commodities though I think there are more similarities to the trading psychology of commodities and forex notwithstanding the massive difference in liquidity between commodities and forex.

FT
  • #32
  • May 10, 2019 8:40am May 10, 2019 8:40am
Is it outline, risk means all the possibilities that cause losses in forex?
  • #33
  • Last Post: Mar 3, 2020 1:11pm Mar 3, 2020 1:11pm
In fact, your question is very simple and complicated at the same time, because I can't always explain in a reasonable way why I did something in a certain situation, sometimes it happens almost at the level of feelings, when you just realize that today everything will work out. But in no case can you rely on it as a rule. Whatever happens, you should stick to the statistics and use exactly the amount that you have available from your capital, I am against risks that can destroy half of the capital in a few hours, it makes no sense if we talk about trading as a business, not as some kind of entertainment. And it seems to me that this approach is followed by a large percentage of traders.
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