Friday, 20 November 2015

Risk management is everything

It was a rather subdued day in the US equity market, although the sp' did break a fractional new weekly high of 2086. All US indexes are set for very significant net weekly gains, almost completely negating last week's declines. New historic highs look due, especially if the Fed raise rates at the Dec' FOMC.



Aside from the market... for which there is little to be said today... I wanted to bring up a story that is increasingly doing the rounds...

A trader - Joe Campbell, who blew up his E-trade account via a bio-tech short.

First.. see:  RutRho blog

Second: the 'gofundme' for said trader.


It never fails to disturb me when I read about such a trading disaster. There can be no excuse for it. None.

So... lets get this clear... the trader had $37k... decides to risk it all on shorting KaloBios Pharmaceuticals (KBIO) - from somewhere around $2.00, with KBIO then exploding higher in Wednesday AH... the trader was not just zeroed out.. but saw his account implode to -$106k.

KBIO, daily

KBIO settled higher by 397% @ $10.30, but that was a long way under the opening level of $14.00. The daily closing candle was of the black-fail type, with the stock maxing out in the upper gap price zone from early January.

The trader noted he covered in Wed' AH for an average exit of $18.50.

With the Thursday close of $10.30, his exit now looks even more disastrous. Rather than having closed out for a $16 loss per share... he could have closed out for around $8.... halving his trading loss to $50k or so.

I have some sympathy for the guy, but having broken almost every rule in my (and probably many others) trading book, I'm mostly just annoyed.

As for 'gofundme'..

As of writing (10pm EST), JC has raised $5245. No doubt, by late Friday.. the 7000s.. and maybe 10K by end of the weekend. Who knows, maybe someone with serious money will generously clear the entire debt in a single donation.

JC has stated he wants to pay off E-trade, and even get back to trading. I find the latter a little disturbing to read, a mere day after his account imploded. Even if his account is refinanced, I'd seriously hope he takes some months off to reflect upon things.

I could write a good book on Risk management. Part of my academic background was in the psychology of risk, and the basis for the decisions (especially bad ones) that people/institutions make.

A few of my core rules...

1. Never borrow to speculate.. or 'invest'. The cost of such money is almost always going to negate gains (if any) from trading.

No trading on margin ever.


2. Steer clear of the worse sectors/groups... namely bio-tech, momo stocks.

Most bio-tech companies lose money, pay no dividends, and are inherently unstable.

Most momo (momentum) stocks are either in collapse mode.... or soaring. For those who can stomach roller coasters though, I do understand the attraction.

3. Position size management.

This is something I could give a hundred examples of, and it still might not be enough.

Suffice to say...  whether someone had 50k, 100k, or 1 billion to invest.. they'd have to be clinically insane to put ALL their money into a single investment vehicle/company.

Strength in diversity, right?

4. Trading stops.

Everyone is different in what loss can be considered tolerable. Many in retail land sure would get upset on a -5/10% daily decline (not least via the leveraged ETFs or options. Yet for some... its bearable.

What should be clear... at some point... a 'white flag' MUST be waved.

Further... where a position has gains, a good stop to protect some of the gains is imperative.

*of course, in AH (after hours), trading stops do not apply. Even if JC had been 'babysitting' his KBIO position on a second by second basis, the price would have moved so quickly on the news, he'd still not have had time to make an emergency exit without incurring a monstrous loss.

A clear solution to that problem of course is to never hold positions beyond the 4pm close/overnight.

5. Worse case scenario

This particularly relates to those who write options or directly sell short a stock - something I have never done (if I want to short a stock, I'll either buy option puts, or a short side index/sector ETF such as SDS or ERY).

Consider this trade...

Trader 'Writes' (sells) 20 put contracts, strike $10, listed at $1.00 ($100 a contract), on a stock that currently trades @ $10.00

Total income from the 'write'. $100x 20 : $2000

Worse case scenario: stock goes to ZERO.

Trader 'buy to close' @ $1000 per contract x20....  $20,000

$20,000 - $2000 'write' income:  $18000 net loss... worse case.

Any trader writing such option puts (or short the actual stock) should (at least in my view) have $18,000 of cash sitting in their account ready to cover the worse case loss.

Yet, from what I know, that kind of reserve requirement is simply not the case with most (if not all) retail brokers. This lack of 100% backing against the 'worse case scenario' is why traders like JC can not only get zeroed out... but actually see their account balance turn negative.

*One of these days, I'll get around to detailing more on risk management, for now, that will have to suffice.

Update from Oscar

I'm sure Oscar would have some things to say trader JC about risk management.

Looking ahead

Friday has no scheduled data.

It is opex, so expect increasingly chop into the weekly close. 

*Fed official Bullard is due to speak in the early morning, and Mr Market will clearly be looking for further confirmation that the Fed will likely raise in December.

Final thoughts

We've all had bad trades, whether long or short. Yet... the story of trader JC should be a good reminder of what can go wrong if 'reasonable' rules are not held to. I for one know that under my rules I'll never see my account balance turn negative.. its simply not possible, as I don't trade on margin.

Maybe... just maybe.. if JC does get to recharge his trading account, next time he'll avoid the bio-tech/momo stocks, and never EVER trade on margin.

Goodnight from London

ps. If you ever read this JC. I do hope things work out for you, but hell, if you even start to consider trading on margin in bio-tech/momo stocks again... you need to just turn off your screen, and quietly walk away from the market (aka, the twisted casino)... forever.