Risk - how to measure

Note: I am a trend follower

Question:

I don't even know how to explain it in simple terms, but how do you quantify / measure and what is it called, when say for example you move from equities to another instrument to seek safety, and say the market crashes. Your potential loss is whatever the crashed market was, but you were not exposed to that, due to a move to safer instruments.

How to measure or articulate this to investors ? This is akin to someone asking "why should I wear a seatbelt" Well to protect you in case you crash. "But I haven't crashed yet, so how do you quantify the value of putting the seatbelt on each time"

Does this make any sense ? Does anyone get what I am trying to determine ?

Thanks guys

 

dynamic risk rebalancing.

It's common to measure the effects using risk measures (e.g. volatility, drawdown, etc) of the portfolio against alternatives.

 

umm maybe i'm simplifying it too much but you're basically buying insurance (like a put option).

 

Try 3 sigma events.

 

I think you need to measure the risk by the cost of insurance worth the amount of reward.

For example.

You got in a trend and you made so far $ 10,000. Each quarter you now spend $ 1,000 to protect your gain so for the year assuming the trend has stopped, you made a total of $ 6,000 which is minus the $ 4,000 cost of insurance on these gains.

However, another way to trade is you could incorporate a little TA in the trend following system.

1) You have a stop. You could move the stop up some while leaving the target alone. This way you decrease risk but not reward.

2) You use the standard system mention in the books where you stay long until you get a reversal signal where you either get out, or then trade in the opposite direction hoping to catch a new trend.

3) You can also continue to use options but only start using them as you make enough gains to pay for the cost as noted in my above example where you are willing to pay $ 4,000 to look in a gain of $ 6,000. The problem of too much insurance before the gains is that if the trade does not work out, you lose on the trade and the insurance.

 

+1 to everything ORCL wizard said above.

re using options to protect gains, one way is to use a cost free or nearly cost free collar. mark cuban famously did this when he sold broadcast.com to YHOO and didn't suffer when YHOO blew up during the tech burst.