Food for thought:
“What kind of risk are you willing to take to get this profitability? Consider whether you are willing to suffer the occasional large loss in return for consistent small profits. For example, risk arbitrage as a trading strategy has lots of small profitable trades but the size of the average winning trade is overshadowed by the size of the losing trade. Do you need to make modest profits but take little risk? Do you need to make huge profits but can afford to take sizable risks? I usually start interviews with potential clients by asking them how much risk they are willing to take. Can you afford a loss of 5%? How about 50%? Defining the amount of risk usually defines the type of system that is required. Don’t forget that it is very easy to acquire risk. One of the keys of profitable trading is controlling and managing the risk that is acquired. One of the key risk elements to look at is the risk of catastrophe. For example, it may be that two systems have identical returns but one has a higher risk of catastrophe. I remember in the early days of system trading how moving average crossover systems were all the rage. The basic concept is to buy the instrument when the, say, 10-day moving average of price crossed over the 40-day moving average of price, and short when the reverse occurs. In fact, this is a profitable system. But one of the problems is that moving averages are, by definition, behind the market. It is quite possible for an instrument to lose 90% of its value before the sell signal is triggered! Of course, it won’t happen very often, but the mere potential of this risk must be considered in the system selection process.”
Chairman, Courtney Smith & Co.