An interview between Stuart Mcphee and Ray Barros on finance risk management.
Stuart: I understand early on that you were almost forced to recognize and appreciate how important managing risk was. Was that position sizing, was it where do you set your stops or all of the above?
Ray: I didn’t manage the stops initially and then you read every book to put the stops in but then I didn’t manage portfolio risk. You are spread over a number of instruments and even if you risk 2% per instrument then you leave twenty instruments open. You know suddenly you have got 20% open you got to have that. You got to have risk for trade, how many contracts are you going to take so all of those things I had to learn the hard way.
Stuart: I am sorry to hear that. A lot of people make a lot of mistakes early on and it’s only through making those mistakes yourself. I mean you can read twenty books that say you know position size well and do this and do this. You go through and make all those mistakes and it hurts and what you say was since your wife funded you early on, that probably didn’t sit terribly well with you so it forces you, I guess.
Ray: Yeah, and I think early on you know a couple of times I have mentioned to you that I have an excuse to say, back in my day no one was there to really assist. I mean the stuff we had then is nothing compared to the assistance you get today. I mean you get some really good people out there trying to help.
Stuart: Okay, so it’s real big difference. About finance risk management, and you know about how important that is, and I hope others realize how important managing risk is. But a lot of questions we get from clients, it’s all about entry and you do the seminar thing and someone will talk about managing risk and you might have a good size audience but then someone else is talking about entry and in the room there is standing room only. Because this is the key to success. What are your thoughts on entry and why people focus on that so much and do you have guidance to people about entry and methodology and setups.
Ray: I think they have a place. I think your trading rules have probably the least important part. In my view identifying what are the trends, where you are going to take a trade and whether that trade is setting up, it’s much more important. The entry almost necessarily follows those things.
Secondly, I can’t remember when I brought the lower. I don’t think I have ever done that so at some point after entering the market you are going to take some heat. So you need to know with your methodology how much heat is normal. John Sweeney wrote a book called Maximum Adverse Excursion and Maximum Favorable Excursion. I would recommend that to anybody who is talking about trading and talking about entering because that approach tells you statistically how much heat you ought to be able to take in your system and it will still make a profit.
If you know that, it takes the pressure away from you. I have got to buy the exact low I want to buy within two ticks or sell it within two ticks and often some systems just aren’t geared for that sort of thing. So the beginner trader must quickly come to terms both with the rules for entry and finance risk management.