The work of risk analysis and management is not only limited to price volatility and probability but also includes capital management.
"You have to set up a rigorous capital management system. You must never allow yourself to get deeper and deeper. You can use some kind of maximum consecutive loss rule, or set a risk value. You can also use some kind of operating rule, such as: 'Losses cannot exceed a certain limit'".
"You have to have this kind of psychological norm, and you can never take risks beyond the set range. You have to make sure that you won't be eliminated, which is very important. Things can easily get out of control, and you have to have clear rules."
To design a capital management system, you can consider the following points:
- How much is the maximum risk amount that I can bear in any single trade? In other words, how much loss can I bear at most in each trade? Please note that a series of trades may suffer losses continuously, to retain trading strength, how much loss can I allow at most in each trade?
- Once the trading position is established, how much percentage of loss am I prepared to bear at most? Some people use the concept of "value at risk" to make this decision, which is a value calculated based on the probability distribution of possible outcomes of all open positions, representing the total amount of risk borne by the position (under a specific confidence interval, VAR represents the expected value of the maximum loss in a certain period under normal market conditions).