Risk management

Two of the most important skills for long term investment success are capital allocation and risk management.

Capital allocation tends to get most of the attention in the press, which publishes headlines like “Where To Put Your Money Now”, or “10 Hot Stocks To Watch”, or perhaps a list of recently funded startups. This is especially true when markets are good and everything is going up.

Risk management isn’t nearly as interesting to the average person. It’s much more interesting to hear about the 800% return in titanium stocks over the past year than the possibility of losing money.

The past couple of weeks have reacquainted investors with market risk. For new investors who haven’t seen a down market in action, this is especially painful. The Indian stock market has been popular with emerging market investors in the US, as well as in India. It had been up around 50% since the beginning of the year but dropped 10% in a single session, and around 30% in a few days last week, triggering margin calls and placing police on suicide watch. The decline in US markets has been tame by comparison.



This afternoon the Enron trial came to an end, with Jeff Skilling and Ken Lay found guilty of fraud, conspiracy, and other charges in the collapse of what was once a $68 billion dollar company.

Barry Ritholtz used Enron’s declining share price to illustrate the importance of risk management and sell stops a few weeks ago:


It wouldn’t have prevented you from losing money, but it would have kept you solvent. The buy-and-hold employee and retiree shareholders probably weren’t so lucky.

I recently became aware of a risk I hadn’t thought of in a while – platform risk. Yesterday I had a profitable short term trade locked in with a protective stop which failed to trigger when the share price turned and passed through the stop level. I asked Schwab to investigate, and it turns out they may be having intermittent problems with certain trailing stops entered through the trading window rather than the custom alerts window in Streetsmart Pro, their client application. They adjusted my trade to reflect the correct stop value, which was logged on their server but not executed.

Trading with unreliable stops in the current market is like driving a car with brakes that don’t always work. I appreciate Schwab making good on the trades, but I hadn’t considered the possibility of correctly entered stops not being executed when hit before yesterday. Kind of like people hadn’t considered the possibility of widespread fraud at Enron before it blew up.



Asset allocation is important, but risk management can keep you in the game when the unexpected inevitably happens.

Big Sur Marathon 2006

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This past weekend I ran the Big Sur Marathon, my 3rd time on the course. I’ve been posting on a separate running blog for a while, here’s a roundup of Big Sur posts:

Runners on Bixby Bridge

Maria moves the markets

I sometimes have CNBC on in my office, sort of as background noise. This afternoon I heard Maria Bartiromo describing her weekend conversation with Federal Reserve chairman Ben Bernanke.

The media and the markets basically got it wrong last week in speculating that the Fed is done raising interest rates.

I’m thinking to myself, “Hmm. That’s going to make some people uncomfortable with their positions.” Especially since this was pretty much the opposite of what people were thinking after last week’s Fed testimony.

Here’s the AP summary:

Last Thursday, Bernanke told a congressional panel the central bank could pause — but not necessarily stop — its string of rate hikes while it keeps a close watch on the economy’s health. However, according to CNBC, Bernanke said future increases will depend mostly on economic data; that stand was troubling to an interest rate-sensitive market.

A spokeswoman for the Federal Reserve, Michelle Smith, declined to comment on the CNBC report

Well, that was fun. Some quick thoughts:

  • If this was intended as clarification of Fed policy, why not say so directly, instead of indirectly? And why not officially comment when given the opportunity?
  • Why did CNBC sit on this all day, instead of reporting pre-open, when they already had the story in hand?
  • Who profited from this? This would have been handy information to have in one’s pocket this morning…

You can currently watch the clip on the CNBC site (requires IE6).

Update 05-02-2006 1030PDT: Trader Mike has a thorough roundup of comments from various blogs.