How The Great Traders Manage Risk

For this week’s TradingMarkets Weekend Edition, we are pleased to present this interview of Ken Grant. Ken has worked with several of the most successful hedge fund managers of all time, including Paul Tudor Jones and Steve Cohen. He has recently written, what we believe will become the definitive text on risk control and portfolio management, Trading Risk: Enhanced Profitability Through Risk Control. In this interview, Ken will show us seldom discussed insider methods of dealing with risk, how large hedge funds apply these principals and how you can use these techniques to become more profitable.

This interview was conducted by Dave Goodboy and it originally appeared at Realworldtrading.com.

DAVE: Hi, Ken. Thank you for joining me today. Let’s jump right into your philosophy on risk control. One of the first things you stress is the importance of having a plan before entering the market. This is very basic, but I know you mention it for a reason. Can you elaborate on having a plan?

KEN: Sure, having a plan seems to be the most intuitive part of portfolio management; however, I do find it is the exception, rather than the rule. This applies to both professionals and non-professionals who are managing portfolios. Most traders and money managers have not gone through the exercise of figuring out how they are going to be successful. Planning how to make efficient use of your resources is the number one planning task for anyone managing money. The fact that most people simply do not do this is causing all kinds of slippage in the markets. It is important to keep in mind that there is not just one plan, which makes the planning function a little less intuitive. When formulating a plan, I recommend a top down approach, which begins with ridiculously simplistic questions, like what am I trying to accomplish? What are my constraints? What are my resources? Then you need to drill down deeper, planning your environment. What markets do you want to trade? What are the inefficiencies of these markets? How am I in a good position to take advantage of the inefficiencies? How can I maximize profits from the market? What are the specific modes of operation I am going to use? This all sounds very simple but I don’t think it’s being done in the universe of risk taking at all. These questions will lead to better use of resources, whether the original plan was correct or not. Hopefully this makes sense.

DAVE: Yes, I understand exactly what you mean except for one thing, you mentioned the importance of “planning your environment”. What do you mean ?

KEN: Creating a clinical environment is a critical aspect of risk management. I am not talking about the physical environment. Approaching the markets in a clinical fashion is key to successfully managing your risk. Now, you must keep in mind, that even in the most clinical environments, things happen.