What is risk management?

This is the first article of a 4-part series of articles on risk. I often hear people saying stock markets are risky. I am going to try and classify and quantify the risks that they perceive. Once they know what to and what not to be afraid of, may be the fear will subside a little.

We all have heard the following;


Not just the adverts, but you all will have at least one each from the following categories in your friends and family:

The one who is terrified of the thought of stock market and actively advises everyone against it.

The one who has tried and burnt her hands in stock market.

The one who’s doing it for a long time but has neither made nor lost too much money.

The one who knows what she is doing and makes consistent money from the market.

The last one is very rare and usually flies under the radar. Except the one who has lost a lot of money, everyone else of the above have done a decent job of managing their risk. And yes, I am including the person who stays away from the market, since she has already made sure she never makes a loss in the market. (There are other ways she will lose her money but we will talk about it in subsequent articles).

If you look up the definition of risk management, you will find something along the lines of identifying and mitigating threats. That is a generic definition. Let us rephrase it to suit our profession. The overarching risk in securities market is losing money. And why do we lose money? Usually because our view of the market is wrong or the tool that we used to express our view of the market is wrong.

You can have 7 views for the market:

  1. Up
  2. Down
  3. Sideways
  4. Up or sideways
  5. Down or sideways
  6. Up or down.
  7. Arbitrage – This is not a feasible stance for most retail investors so we will ignore that.

For example, if your view is that the market might stay sideways, but market makes a directional move beyond your expected range you will lose. Your risk management principles will dictate how much you lose when your trade goes wrong.

I would like to give an example of picking the wrong tool for your directional view as well. Let us say your view was that Reliance will move up in the next 30 days. Instead of buying shares you thought you’ll receive higher ROI if you take a position using options. You buy an OTM call. For half the month Reliance doesn’t move up very much. Due to theta decay, your option loses premium and the stop loss on the option’s premium is hit. You exit the position and a couple of days later Reliance Starts an explosive rally on the back of some good news. You could have held on to the position if you had made a spread with options or simply taken a cash position.

We will talk about many factors that are often overlooked while taking a position in the next article.

Practicing targets

abstract accuracy accurate aim

If there’s one thing we see consistently across all self help books, it’s setting goals. They talk obsessively about setting goals and breaking them down into sub goals and sub sub goals and planning every hour of your day….

Some goals require that kind of dedication and hard work. But some goals require work with carefully selected targets. Much like a company sets sales targets for its employee to reach the goal of profitability, we need to set ourselves some targets to reach our goal of consistency in trading.

As I wrote previously in my blog post, we must focus on what we can control and hence the targets that we set ourselves must be aligned to the same philosophy.

Most traders set targets for profit, or return on capital. I realized I wasn’t walking the talk. Market doesn’t owe me my target. I can’t force the market to give me the returns I expect or want.

Target setting varies from system to system. An intraday trader can reasonable expect to take several trades in a week. For her it might be statistically correct to check the PnL at the end of the month. For a swing trader there could be months where she doesn’t close any traders and PnL will be zero. Or a month could force her to book 3 losses in that month while several trades end in good profit the next. In such cases, monthly PnL isn’t a right measure.

Setting unrealistic targets can mess with your psychology too. If it looks like you won’t meet your weekly target, which you shouldn’t have set to begin with, you might force the trades and give up any gains that you might have made so far.

Also if you have multiple streams of income, you can set a collective quarterly target across all. I would consider trading in Equities, currency and commodities as three separate streams since required fundamental understanding of markets is quiet different in all three.

So set the targets you can achieve realistically with the capital you have. Follow prudent risk management and work on a trading system that gives you consistent market beating risk adjusted returns.

Happy Trading…

P.S. – Due to some personal reasons I will not be able to publish a post for two weeks.

Monthly options portfolio (September – 2020)

Unless it wasn’t clear from my earlier posts, I like trading. I particularly enjoy how well options help you translate your market view into a trading strategy. So I figured why not share some of them here.

BIG DISCLAIMER - I may not have position in the strategies I post here due to margin reasons. Derivatives are the most risky instruments available to retail traders. Please do your own studies before taking any trades in the stock market. I will not be responsible for outcomes of these trades. I do not own any charts or data I share here. Everything is for educational purposes only. I assume you agree to the disclaimer if you continue reading this article. 

There will be some trading jargon in the discussion that follows. So here’s a short key for that:

  • Position – A position in a stock would consist of multiple option trades.
  • Trade – Entry or exit from an options contract.
  • ROI – Return On Investment
  • PoP – Probability of Profit

So there are some rules that I will follow while making these strategies:

  1. Maximum margin used will be 10 lacs.
    After SEBI’s new margin rules, required margins have reduced greatly risk defined strategies. Some of my strategies will be risk defined.
  2. Adjustments, i.e. additional trades, will be taken if any position has the potential to give losses.
    It might take additional margin and hence we will leave some margin unused at all times.
  3. Margin calculation will be done in the ‘India’s Best Trader’ tab of Zerodha Sensibul.
  4. PoP will take priority over ROI.
  5. Strategies will only be in the options which are liquid.
  6. Strategies on stock options will be in current month.
  7. Strategies can be initiated anytime except in the week monthly of expiry.
  8. Strategies targeted at events such as results, court hearings etc, will only be taken if at least twice as much free margin is available to manage any unexpected movements in stock.
  9. 5% of capital (i.e. 50,000) in the MTM loss on a closing basis will be the hard stop to exit any strategy.
  10. After 40-50% of the max profit is achieved, we will look to exit out of strategy depending upon stock movements.

I know these are a lot of rules. But trading without any is just asking for your account to be blown up. Another disclaimer would be that I have constructed this on a weekend so option premiums are according to the closing price on the Friday 4th September. When you track these tomorrow the premiums will be different. Idea isn’t to get the exact entry price but to have positions which will require minimum maintenance through the expiry. If the market moves against any of the positions I might add the adjustments done here. But don’t hold me to it. I will also do weekly expiry trading in BNF in my trading account which I may update separately.

Not all strategies will have explanations as some of them are pretty textbook.

This is part of the positions which will be added as the expiry comes near. All the positions will be converted to MIS on the day of expiry and I will do the expiry day trade.

This is a little complicated one and relies on volatility of the NIFTY remaining high through this weekend. So the next week long options will not lose too much premium to time decay and I will get to keep the premium from this weeks sold options.

So far we have used a little over 6 lacs for these 9 positions. I will update changes, if any, in the captions of those images. Also I will try to find a better way of putting such trades on the blog. Suggestions are welcome.

This is the first time I am putting some of my trades in public. Please do not blindly follow anything you see on the internet including this blog.

Happy trading…