Saturday, 16 January 2016

Mitigating Risk, Managing Uncertainty

16:21 Posted by The Thalesians (@thalesians) No comments

Happy new year! If you're in markets, the new year has been anything but happy. The markets have greeted the new year with more than a modicum of scepticism. Crude oil has continued to trade very poorly. Equities have sold off significantly since the start of the year, mirroring the behaviour of August's sell off. Elsewhere, in FX, risk aversion has gripped the market. The high beta currencies in G10 FX have got trashed. EM has also been hit hard. The market has also been thinking about "one off" events such as Brexit and also to a lesser extent the breaking of the Saudi peg.

In a sense, this whole period has brought to the fore, the fact that a trader's job is literally to manage risk, trying to minimise downside risks and at the same time being able to capture the upside. The difficulty is that whilst in ordinary times "risk" might seem benign, this job can be much easier, during risk aversion, traders are faced with an explosion in volatility. This can make it difficult for traders to stick to their goals, even if they happen to be on the right side of the trade. Short term volatility can force traders out of positions which are fundamentally sound, but still come under stress, when the markets switch from seeking yield to wealth preservation in periods of risk aversion. When it comes to "one off" events, such as Brexit, we cannot simply use probability tools to understand the risks, we also need to use our judgement and an element of qualitative analysis.

So what should we do? Luckily, on Wednesday at the Thalesians in London, Nick Firoozye, a Managing Director at Nomura International and heads of a global team in cross-product derivatives research, will be doing a presentation on exactly this subject of uncertainty and risk. I must admit it's more a product of coincidence that the talk will be happening at this time of market turbulence, rather than some element of foresight on my part! Nick will be talking about his new book "Managing Uncertainty, Mitigating Risk - Tackling the Unknown in Financial Risk Assessment and Decision Making" and also signing copies. In his book, he stresses that we cannot simply use conventional probability to understand uncertainty in finance, and instead we need to seek understand the mathematics of uncertainty. He introduces concepts such as uncertain value-at-risk (UVaR) in the book, which helps to incorporate expert's insights into a risk framework.

I am looking forward to Nick's talk and hopefully see you there on Wednesday, if you can make it!

Like my writing? Have a look at my book Trading Thalesians - What the ancient world can teach us about trading today is on Palgrave Macmillan. You can order the book on Amazon. Drop me a message if you're interested in me writing something for you or creating a systematic trading strategy for you! Please also come to our regular finance talks in London, New York, Budapest, Prague, Frankfurt, Zurich & San Francisco - join our group for more details here (Thalesians calendar below)

20 Jan - London - Nick Firoozye - Managing Uncertainty, Mitigating Risk
29 Jan - Budapest - Robin Hanson - Robin Hanson, Economics when robots rule the Earth
08 Feb - London - Saeed Amen/Delaney Granizo-Mackenzie - CTA/Pairs trading (joint Thalesians/Quantopian event)
29 Feb - London - Jessica James - FX option performance (TBC)
21 Mar - London - Robin Hanson - Robin Hanson, Economics when robots rule the Earth


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