How to build a custom Risk Framework that fits your trading personality
Adapt, Survive, Thrive...
Introduction
For too long I had no clear Risk Framework in my trading. That is quite funny because I work as an Actuary, which is considered as a risk expert in the insurance industry (and to a smaller extent in the banking industry).
I’ve struggled for a long time because all I was doing was applying things I’ve read online that didn’t make sense to me, like ‘don’t risk more than 2% per trade’, ‘use a risk-reward ratio that is greater than 2’ and many others.
I inevitably failed to consistently apply them because I didn’t understand them. I also believe each individual trader should create his own set of rules based on his/her personality.
In this article, I’ll provide you with the framework that I’ve been using for the last few months, and that helped me gain consistency in my trading journey.
KISS Concept
As a retail trader, I believe EVERY aspect of our trading should be kept SIMPLE. You may have heard the KISS principle (Keep It Simple, Stupid). We will never be able to process data as efficiently as Hedge Funds are doing, and we have to fight with different weapons.
From my trading strategies to my Risk Framework, I always apply the KISS concept.
Weaknesses and Strengths
To build a successful trading Risk Framework, you need to know your weaknesses and strengths. I believe we have to learn to live with our weaknesses, making them as meaningless as possible, whilst getting the best out of our strengths.
A good exercise I suggest you do is to list your top three strengths and weaknesses. This will be used as the foundation for our Risk Framework.
For me, it looks something like this.
Top 3 Weaknesses
I’m too greedy;
I become too emotional when the volatility peaks; and
I can’t focus for more than 1 hour in a row.
Top 3 Strengths
I trust myself;
I happily admit when I’m wrong and learn from it; and
I’m passionate about trading.
From these points, we can now build our trading rules/Risk Framework, or how I like to call it ‘The Code’. I’m a big fan of the TV Show ‘Dexter’, where the main character has to live a life full of lies. The only way for him not to get caught and end up in jail is to follow The Code, a set of rules instructed by his father.
The Code
From the above six bullet points, I built The Code, which I try to follow every trading day.
Greed - To avoid being too greedy and turning green days into red days, I now have a target for each day. When/if that target is hit, I close NinjaTrader.
Volatility - I underperform volatile times because my P&L moves too quickly. To tackle that issue, I have stopped trading the market open.
Attention span - I trade 45min per day, every day, at the same time.
Trust - If there is no clear reason to exit a trade, I stay in it.
Low ego - Review of my trades on a regular basis.
Passion - Live to trade another day.
These rules are simple, and easy to follow because they make sense to me. I know why I have to apply them.
Consistency is my main goal for 2022, and the safest way to reach that level is to follow a framework that emphasizes your strengths and reduces your weaknesses.
I hope you learned something from that article, I surely did enjoy writing it.
Looking forward to seeing more from you. Do you plan to post daily recaps here as a way of holding yourself accountable?