Foreign Exchange Risk Management Forex Risk Management
Morning Briefing

Risk:
Money Management:
The Tails make all the difference




20th November, 2002


Treasury Risk Management

The Colour of Money - Series on Forex Hedging

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28th May, 2012

15-25% of the trades make all the difference
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Looking back at our Trading Performance over the last 15 months, I find that it is roughly 15-25% of the total number of trades that have made all the difference, accounting for 65-155% of each month's profit or loss in each currency pair.

For instance, we made an unleveraged profit (all our trades are unleveraged) of USD 1053.22 on USDJPY in Aug '02, on an average investment of USD 41,667. We had put on a total of 13 trades, 7 out of which were profitable, while 6 were not. Out of these, 3 trades together produced a profit of USD 920.79, or 87.43% of the net profit of USD 1053.22 for that month.

Similarly, we lost USD 1027.05 on USDCHF in Sep '02, even though we had 9 winning trades and only 6 losers, out of a total of 17 trades that month. It was just 3 trades (17.6% of the total 17 trades) which produced a loss of USD 1594.58 (155.26% of the total loss of USD 1027.05). In other words, if we had NOT lost money on these 3 trades, we would have had a positive month in USDCHF in September, earning USD 567.53!!

This phenomenon is seen to be repeated for each currency pair in each month, and holds true even when the time frame is elongated to 12 months (and more). A certain Mr Steidlmayer (unfortunately I do not know who exactly he is) is quoted as saying, "Trading is 10 months of grind and 2 months of gravy. If you can stay ahead in the 10 months of grind (or at least lose very little), the 2 months of gravy will make you a very successful trader". In terms of a business metaphor, I read the following somewhere: For most businesses, 75-85% of the customers merely contrinute enough to meet the running costs of the business, and it is only 15-25% of the customers who provide the big earnings due to which the firm/ company remains in business.

The Tails make the difference
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We have plotted the Histogram of actual Trading results in EURUSD, taking into account ALL the trades over the last 15 months, upto 11-Nov-02. The profit or loss (in pips) is plotted on the X-axis. On the Y-axis we have plotted the number of trades that have occurred within a certain range. Thus, we have 38 trades making a net profit of 0-30 pips and 42 trades making a net loss of 0-30 pips. We find that 129 trades out of the total of 153 trades over the last 15 months (average 10.2 trades per month) have produced a profit or loss in the range of +/- 60 pips. Or in other words 84.3% of the trades have been within 60 pips, whether profit or loss. Further we find that the number of winners is almost equal to the number of losers in this range, with 61 winning trades, as compared to 68 losing trades, effectively cancelling each other out.

In terms of the Histogram, only 15.7% of the trades, which have seen more than 60 pips profit/ loss, constitute the long tails of the histogram on either side. Looking more closely, we realise the stark truth that, only 7.85% of the trades have contributed to have accounted for the bulk of the USD 19392.50 loss we have incurred in EURUSD over the last 15 months!



Cut the Negative Tail
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Therefore, it can be said that IF we had NOT made THOSE 7.85% unprofitable trades which saw more than 60 pips losses, we would have made a net profit in EURUSD over the last 15 months. This does not mean, of course, that those trades can be wished away. It is possible, however, to take steps henceforth to ensure that no trades stray into the Negative 7.85% Tail.

HOW?

By setting Stop Losses less than 60 pips, preferably not more than 30-40 pips, on ALL Trades and then not widening those Stops. This will bring us to the topic of Risk-Reward, which we will discuss in the Evening Edition.

Your comments, suggestions, queries, feedback, experiences are invited on these topics.

Thank You.
 
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