In this week’s Huffington Post piece Richard Branson, the intrepid British entrepreneur writes, “The private space revolution is gathering pace. In the first years of operation, Virgin Galactic, which has already signed up nearly 500 customers, aims to take more people up to space than have been there in the first 50 years of space travel. Those visionary individuals’ early commitment will help us develop future technologies that will soon be applied to quicker and more environmentally sound ways of sending payload to space and eventually those transcontinental tickets.” To which my first snarky thought was, “Sure that ‘s going to work until the first crash.”
Yet the moment I had that thought I instantly regretted it. Years of trading have made me hypersensitive about risk, but the truth of the matter is that progress is impossible without risk. Branson is making a valiant effort to advance our exploration of space and I wish him the best of luck. Yet his project would never get off the ground if he didn’t have access to some sort of risk control. I am sure the Virgin Galactic venture carries insurance probably from Lloyds, allowing Brason to operate with some measure of security.
The subject of insurance is an interesting one for us traders to contemplate. Insurance companies are in the risk taking business and therefore have much to teach us. The most important aspect of the insurance business is that every policy has a defined payout. Insurance companies always capitate their risk in order to know their maximum exposure. An insurance policy on Virgin Galactic may pay out 100M but not a penny more, so that if Sir Richard somehow faces a $1 Billion liability he is on the hook for the rest. By keeping their risk defined insurance companies can maintain strict control over their liabilities and hopefully remain profitable.
As traders we don’t have quite the same luxury to micro manage our risk as slippage and gaps can run roughshod over our stop orders. However, if we contain our trading to intra-day time frames we can closely adhere to the discrete bet model practiced by insurance companies.
Of course you can do all the right things and still lose money in insurance or in the market if you hit a statistically adverse sample of risks. An insurance company can write a series of perfectly valid, actuarially sound life policies to a group of healthy 35 year old men and then wind up paying out massive amount of claims if that whole group dies in a plane crash. Similarly traders can experience a much greater frequency of stop outs than their back test would indicate if market environment suddenly changes radically.
That’s why as traders it is always important to remember two things. First, its not your fault, especially if you are following your trading plan properly. Secondly, only use money you can afford to lose because even the best strategies are subject to risk of ruin if you happen to hit a highly unfavorable market environment. Be like an insurance company, treat trading like a business rather than as an affirmation of your self worth.