Emergency Shutdown On Trading
In the same way that a small spark can cause a big explosion, a single trade can cause big financial damage.
Trading financial assets is a risk activity, but it doesn't mean that a trader should be exposed to ruin while trading. It is a fact that risk can’t be eliminated, but it can be managed.
A Control System And A Safety System
The management of risk can be divided into two levels.
The first level refers to a scenario where things are under control or when the market is behaving as expected. The management at this level involves the concepts of diversification, trading frequency, and position sizing. In this case, the process of decision is done before opening a new position.
The second level refers to a scenario where things are out of control, It happens when one or more variables are behaving in a weird way, a condition for which the trading system was not designed for. In a scenario like this, the best thing to be done is to close the positions ASAP. That is the emergency shutdown that keeps traders safe in the money game.
The Emergency Shutdown System
In order to close a position ASAP, a trader can not wait until the price trigger the stop loss. The reason for this is that every time the price triggers the stop loss it will be the worst price since the stop was placed.
A good way the close the positions is by monitoring other variables beyond the price, such as implied or realized volatility, volume, correlation, etc.
The trading system should work under the favorable conditions that may be defined by measuring variables such as those mentioned above. When those variables move out of a predefined range this is the trigger to close the positions.
Triggering a stop loss by the price is the last resource. The stop must be located far enough in order to avoid triggering it when the situation is under control and also to give the chance first to other variables to trigger the emergency shutdown at a better price.
Conclusion
In order to be a successful trader, it isn't enough to have profitable trading systems. The management of risk is something essential to ensure survival in the money game. With the management of risk, a trader can design a scenario where things will be under control, and prepare efficient strategies to get out of positions if this control is lost, building a specific emergency shutdown system for that.
