May 13

Five Ways to Avoid Losing $2 Billion Dollars.

It truly baffles me how ‘professional’ traders and bankers can prove themselves to be so ignorant of THE most basic, and THE most important aspects of interaction with the financial markets.

As our friends at JP Morgan demonstrated even the apparent pros manage to blow things up with alarming regularity, but the fact is it’s actually really easy to make sure you never lose $2b.

5 Things You Can Do To Avoid Losing $2b.

1.  This is the most well-known rule in trading, but somehow it manages to get ignored by people because quite simply, they have a death-wish.

Never risk more than 2% of your account on a single trade.

Particularly for large accounts, there is absolutely no reason to risk much more than 1%.  For smaller accounts that are less than perhaps $10k, you might be okay upping that level slightly simply because it’s much easier to regenerate a $10k account through savings than it is to regenerate a $100k account in the same way.

2.  Don’t trade instruments you don’t understand.

Just don’t.

And this applies ten-fold if you are not adhering to rule 1.

Before you trade a new instrument – particularly a new derivative –  you need to know what they are, how they work, and what their relationship is to the underlying stock.  Most importantly, you need to know what a movement of one point means to your bottom line.

3.  Don’t trade illiquid instruments

There really is zero point entering a position that you can’t get out of.   Depending on your account size, illiquid can mean different things to different people but as a general rule if there is any doubt you can get out, don’t trade it.   Similarly, if it’s got a chart that’s full of holes it’s best to leave it alone – if most people aren’t interested, you shouldn’t be either.

4. Keep your strategy simple.

You’re long a straight stock position which you’ve hedged with put options, but you’re really convinced your stock is going to sky-rocket so you’ve hedged your hedge with a call option that has a OTM strike and a 30 day expiry.  Then to manage the fading theta you’ve written a call to offset that part of the trade, and by the time you’ve done that and named it something nature-based like ‘The Nickel Albatros,’ you’re pretty much done.

Done for, that is.

Because who the heck knows what has to happen for this position to be profitable?  It seems to answer every question but in reality it just makes a mess.

If you want to go long, go long and have an exit point if it goes against you.  It doesn’t have to be any more complex than that.

5. Handle Leverage Very, Very Carefully.

Leverage can rip the eyeballs out of your head if you are an idiot.  Remember that if you want to turn your $10k into $100k in 3 days, the odds are high you’ll lose your home.  And your wife.

Get it wrong and you’ll be steam-rolled flat.

So you can see it doesn’t take a brain surgeon to avoid a $2b loss, just a brain – it’s just unfortunate that a brain doesn’t seem to be a pre-requisite for high finance.


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  • brmr

    I agree with your points and it’s good primer for many beginning traders.

    But the rule of 2% is good for 2 reasons reducing the risk of ruin and reducing volatility which many institutional investors are concerned about.

    For example i’ve read some where that bridge water and soros fund management go above the 2% limit on a couple of ideas where they have high convictions and that too with a bit of leverage. soros bet frequently as much as 10% to 15% during 80’s & 90’s on a few high conviction bets ( especially the pound & during Asian financial crisis). But in general they bet less than 1% on many of their ideas. That’s how they generate high returns during good times conserving capital during bad times generating high average returns.

    It again depends on the strategy. Many value investors bet as much as 20% of their capital on one single bet( including buffet).

    As Steven Cohen said Concentration, Leverage & Iliquidity make a deadly combination for traders.

  • Jox

    I understand the CIO portfolio at JPMorgan was $400B, in which case, the $2B loss was just 0.5% !!!

    • http://roguetraderette.wordpress.com Rogue Traderette

      Ha! Well there you go – losing $2B isn’t a big deal after all! :)

  • Full CIrcle

    If I had but one post to share with a new trader it would be this one; succint, to the point and, from years of experience, oh so true.

    • http://roguetraderette.wordpress.com Rogue Traderette

      Thankyou – you are welcome to share it far and wide :)

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  • lee

    Interesting view Jessica, all very important for traders that are risking there own money. Locals and day traders like you and I…..However; when you are paid obscene amounts of money by an organisation that thinks the state will bail out its mistakes the rules are different. The risk/reward = if its a winner i’ll get upwards of $100 mil bonus and all the kudos of being a master of the universe…if it’s a loser I may get the sack….so i’ll just walk into a hedge fund my former school friend runs. IF i feel the need to have a job. Remember these guys have a pulled in lifetimes salary on a yearly basis.


  • ted

    best simple rule is to be on the right side of the trade

    • http://roguetraderette.wordpress.com Rogue Traderette

      If only it was that easy!

  • http://www.facebook.com/profile.php?id=789924679 Patrick Dugan

    Rules that apply to small-timers who can turn a position on a dime don’t apply to hedging a trillion dollar portfolio – I think this story is most indicative of hidden liquidity risks in the post-QE era.

    • http://roguetraderette.wordpress.com Rogue Traderette

      I disagree. Respectfully, of course ;)
      I think that the challenges are different for the big guys, but the rules remain the same. And it’s managing those challenges that they get paid the big bucks for.

      • http://www.what-are-my-options.blogspot.com Patrick

        Sure, they over-leverage selling gamma even if in mundane forms, and the scale of leveraged finance sort of demands it. I like Hugh Hendry buying CDS with 1.5% of assets, but him firm manages well less than a billion. Too big to succeed. Individuals are differently vulnerable.

      • lee

        You are right and Warren Buffet will testify to that. But the too big to fail culture has meant that large “investment” banks just punt away for a quick buck expecting the bigger fool theory to make them a winner….if not they suffer very little in terms of financial consequence. If day traders were to behave like that we’d be selling our house to pay back the leverage!

        • http://roguetraderette.wordpress.com Rogue Traderette

          Absolutely true!