3.1. A PICTURE OF SUCCESSFUL RISK MANAGEMENT

Risk-taking is about a willingness to enter into the unknown, to take a bet based on insufficient information in an unpredictable market. Successful risk-taking behavior is the ability to take risk in a controlled way, follow the rules, manage drawdowns, cull losers, add to winners, express conviction in ideas in terms of sizing, and use capital appropriately. Most portfolio managers have the capacity to do this, but there is a range from those who are very thorough and cautious to those who are swashbucklers. Some people are not compliant and need to be better controlled by persuasion; some people are risk averse and need to be encouraged to use more capital; some people are not adequately hedged and not risk-controlled enough. Some people hold onto losers too long. Others don't hold their winners long enough. Others look for an edge in little-known or -followed stocks (e.g., microcap stocks or small-cap stocks). These give them an edge but present liquidity problems such that if there are problematic or stress events in the market they cannot get out of their illiquid positions—not a good way to manage risk.

The successful trader, though, is a goal-oriented risk-taker with good abstract reasoning and not too much of the cautiousness or thoroughness that might interfere with his ability to trade stocks in his portfolio. The person's risk profile may be more cautious and thorough if he is going to be a long-term value investor. In that ...

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