Trading Insights from the 16th Century

A complete trading strategy not only focuses on when to get in, but also when to get out and even more importantly, on how much to risk. In the long run, robust risk management should make the difference between a successful trading career and a blown-up account.

While you might think that risk management is a relatively new art and science, William Shakespeare quickly teaches us otherwise giving us a short glimpse at basic diversification, position sizing and the right trader mindset in the opening scene of The Merchant of Venice, where Antonio states:

My ventures are not in one bottom trusted,

Nor to one place; nor is my whole estate

Upon the fortune of this present year:

Therefore my merchandise makes me not sad.

• The Merchant of Venice, Act I, Scene I

So let’s have a look at the components the great playwright identifies in this short quote.

“One Bottom” & “One Place”

Antonio is a merchant and his merchandise is transported in ships and stored in warehouses. They are the shell around his assets or to paraphrase in our terminology: his account. It always made sense to me to have multiple trading accounts. There are many great brokers available for your trading and diversifying your accounts mitigates several potential risks by addressing account protection and technology & geographic diversification. So if for example one data center is going down and you might not have access to your account with broker A, you can easily hedge your positions with an offsetting trade with broker B on the other side of the country, or even a different continent. Broker C might give you easier access to certain asset classes,having choices is always good.

“Whole Estate”

When Antonio mentions that his “whole estate” is not at risk, this is a good reminder of position sizing. A lot of research has been dedicated to optimize position sizing and the key factor is to stay small in your trades. The 1% position size we teach at Trade With Precision is well in line with that research has discovered. Consequently, it is unsurprising to learn that many top traders adopt the ideas Shakespeare intuitively got right.

“Fortune of this Present Year”

The reference to “this present” year” is another hint at diversification. Here Antonio tries to spread out his risk over multiple ventures and years. In general, we try to avoid risk clusters, like having multiple exposures to one market or in the case of futures and options to one product / expiration cycle. Let’s assume that you have currently several forex pairs on your watchlist and good trade opportunities setup at the same time. Usually you want to avoid trading the same currency in multiple trades at the same time. If, for example, I get good entry opportunities in EURUSD and AUDUSD concurrently, I will pick the best setup of those two. Both trades would involve exposure to USD and the correlation of the trade results is just too big such that I want to avoid that risk cluster. Another example would be precious metals, if I am already short silver, I probably won’t enter a short position in gold at the same time due to cluster risk.

“My Merchandise Makes me Not Sad”

Here we have a good hint at the perfect trader mindset. You shouldn’t be worried about your positions and your trading. You know that you most likely will be safe thanks to proper risk management. Just think about when Antonio sends out his ships he has no opportunity to influence the weather, pirates or market prices at destinations of his ships. Therefore, he correctly uses the word “fortune” to describe the random / statistical nature of his endeavour. So his only opportunity to diversify and manage his risk is at the beginning of the journey. Same is true for trading: the only point when we have total control is at order entry. Risk management must occur at order entry!

There you have it! Who said you couldn’t have a great time with Shakespeare and learn something about trading at the same time? And still people tell tale that there was no money in literature...

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• Tuesday 25th August 2015 @ 8pm London, 3pm New York, 5am Sydney (next day) and 7am Auckland (next day)

Regards,

Philipp Pfitzenmaier

The TWP Team