The risks involved in forex trading are significant. At the same time the profits are huge. It is often said in the investment world that the greater the risk of trading the greater the potential for profit. We can only get the huge profits we want in Forex trading if we manage the risk well.
Let's learn how Jon Najarian manages risk so we can better manage our risk in forex trading.
Derivatives are risk management tools. Just like any commodity, you can control risk by buying or selling. Derivatives are trading tools that transfer risk. Top traders have a deep understanding of the nature of risk, and perhaps the most notable feature is: that they all hate risk, they all guard against the possibility of error.
"I am very averse to risk. You may see some people hanging on the wall: 'Risk is not the only way to make money.' Any position must allow yourself to continue trading tomorrow. This is very important. Retaining tomorrow's trading strength is more important than not making money today."
"We always strive to control risk and strive to set the bottom line. Assuming I want to short the market, just like my current view of the US stock market (April 14, 1997), because I think interest rates will rise and put pressure on the market."
"In this case, would I adopt a naked short strategy? Of course not, we buy and sell options, and whenever the market falls, we buy a bunch of call options, lock in the existing profits, and guard against the market rising and forcing us to spit back the profits in hand. There are only a few good opportunities a year. The Federal Reserve intends to raise interest rates, which is of course an opportunity to short the market. But we will continue to adjust the hedging position and lock in the profits, and we will never adopt a simple long or short strategy."
"When we enter the market, we will adopt a hedging strategy. (After hedging, if one position loses, another position will provide profit. Hedging is equivalent to insurance against errors. For example, if you buy a call option, you can sell other strike prices or expiration months of call options or buy put options.)"
"We may be very bearish on the market, and the Federal Reserve may announce a rate hike at any time, but we will take some hedging measures so that we will not hurt our muscles if we judge wrong."
"During and at the end of each trading session, we will evaluate whether the market agrees with our preset position. If the answer is yes, we will continue to hold the risk position and adjust the hedging price downward."
"If we think that the market's lower limit space is not large, the market may rebound from the bottom, we will end the long position of the put option, but will we continue to hold the naked long position of the call option? No, unless we think the market has potential on the upper limit, we will not simply withdraw the risk position and turn the original hedging position into a naked risk position. This is not the way we trade."
Najarian emphasizes the fact that trading is not a gamble of life and death. It's better to have a green hill than no firewood. To stay in the field, you can't lose all your chips today.
Therefore, although the naked position without hedging can provide higher profit potential, this is not his trading method. The hedging position is equivalent to a policy, you pay the premium and guard against a major disaster.
To save the premium and not buy insurance, maybe the speculative mentality that people often have, but a disaster may sweep away your belongings, and you will never be able to enter the market tomorrow. Therefore, risk management must have the self-discipline of hedging.
"When we establish a spread trade or a hedging trade, we often think: 'God, if someone tied me up and stuffed me into a closet, I would make a lot of money now.' Because the stock price continues to fall, we continue to extend the hedging call option downward. Yes, this is the curse that hedgers have to bear. But this is also the reason why we can sleep peacefully every day."
Najarian knows that he has bought disaster insurance, so he can relax more.
"After a big drop of 148 points on Friday, the situation was really bad, and there was almost no buying. In this situation, if I was stuck in a position, I would be panicked. But we slept as sweetly as babies. At that time, I was in New York, enjoying a good time. I didn't even enter the trading hall on Friday, because we had already laid out properly and the transaction would proceed according to the plan."
Najarian continued to explain the benefits of hedging.
"Of course, sometimes we also wish we hadn't followed the rules, but usually we are still grateful for our self-discipline. We see a lot of people pushing in all the chips, ready to hit a home run. Even in the face of a major market, even if you are ready to hit a home run, we will still control the degree of risk."
"Even if we buy a lot of premium put options, we will still sell premium put options as hedging. Even though we think the market will fall sharply, we will still control the risk. For example, if you buy a put option at $4, sell another put option, and earn $2, you only bear $2 of risk. So we can sit at the table for a long time. Those who don't hedge, if they encounter adverse market conditions, they may only have to pat their buttocks and leave, but we can continue to play."
Because of hedging, Najarian can stay within his comfort zone and exert sharper judgment. You might as well recall the last time the market rose or fell sharply and made you panic. Do you have a feeling of the end of the world? Does it make you feel stomachache? Does it affect other trading decisions?
If so, do you consider hedging? Of course, you have to calculate the cost of hedging, and you have to evaluate how much profit potential the risk position is willing to give up. In addition, you also need to consider how hedging affects the risk/reward ratio, and when to increase or decrease the hedging position. Risk is not a problem at all: as long as you are willing, you can control it precisely.
Najarian mentioned an example to illustrate the importance of hedging. This story happened on September 29 and 30, 1991, involving a catheter manufacturer in Minneapolis. Mercury was the designated primary market maker for this company.
"Within a day, the stock price fell from $88 per share to $56. The market continued to sell short, and we also kept taking over all day. In addition, we also held a short position of put options, and whenever the market fell beyond a certain level, we sold put options, so the long position of the market continued to accumulate, and the number of sales increased."
"This completely violated the proper practice. When this trend started, we lost $1 million, and during the trend, the loss accumulated to millions. Finally, we came to our senses and turned back to our best method: any transaction must limit the loss. Within about two months, we slowly made up for the loss, relying entirely on our self-discipline."
"As I said, I don't care how much money you make today, I want you to continue to make money tomorrow. At that time, our traders wanted to make a lot of money, because before the earnings report was released, the premium was outrageous, so they kept selling."
"We shouldn't just build a position in one direction. We should buy some insurance, but we didn't. When things happened, the trader who handled the stock only saw the money and calculated how much money he could make from the premium income tomorrow. In addition, the risk/reward ratio was also wrong. Our traders knew that the market would fall, but they didn't expect it to fall so deep."
"This is a typical example. Even if we think that the probability of an event happening is as high as 80%, we should not ignore the risk at all. Therefore, the key principle is 'how we will be tomorrow', not how much we make today. We must care more about tomorrow than today."
With the above explanation of Jon Najarian Managing Trading Risk, we know the importance of managing trading risk and exactly how to do it. We can pay better attention to the management of trading risk in our future forex trading practice, so that our risk in forex trading will be significantly reduced and controllable. So that the profit is not far away from us in forex trading.