Global macro traders thrive off of risk. In fact most traders do as without risk there is no reward. That being said one of the most important things that a trader can do is to incorporate several levels of risk management into their trading process. Lucky for us there are about a gazillion different ways to try and mitigate and at times virtually eliminate risk.

One of the first and most important risk management tools available to the macro trader is the practice of positions sizing. Position sizing is when you determine an optimal amount to risk on a trade. Obviously several factors can go into your position sizing algorithm. You can look at the probability of the trade working out. You can look at the over all risk versus reward ratio. And you can look at how much of your portfolio you want to risk. Obviously there are hundreds of potential variables that you can input into your position sizing model.

Now that you have your position sizing algorithm it is time to focus on eliminating or at least minimizing tail risk events. Tail risks are for very improbable events that most investors never even look at or consider. Any stock can go to zero. Your CEO might be committing fraud. Your town could experience a huge earthquake. These and countless other events are considered tail risk events.

So one thing that is important is to consider tail risk. Tail risk is essentially risk that is always present and that is highly unlikely but not impossible. CEO fraud, natural disasters, terrorism, and the like are all events that would be considered tail risks. One of the fastest ways to cut off tail risk it to be a buyer of options. Whether you use calls or puts obviously depends upon the position but you can use options to better structure your risk and therefore have better risk management.

Options are very useful to cut off tail risk because they totally limit your risk while allowing for plenty of upside. In fact sometimes they provide a lot more bang for the buck then an outright stock position as they can have a lot of inherent leverage.

Just like any other trading strategy or security there are still risks. In fact there are two primary risks when using an options strategy overlay. The first risk is that you want to ensure that you are paying a decent price and not overpaying for your options. If volatility is high you may be paying far more then they are worth and mess up your risk to reward.

The other major risk is that your time horizon does not fit the trade. If you want to hold the position for years then move on and probably pass on using options. However if you want to hold it for weeks to months then go in and check them out as you can do a lot of risk reduction using options.

Ensure that when you are trading that you look at al the available ways to express your market view. By doing this you will often use options and in so doing improve your global macro trading results.

Last 5 posts by Investment Education Staff

• LEAP Options - November 16th, 2009
• Berlin Property - Invest in the Capital of Europe - November 16th, 2009
• Ways to Invest in Oil and Gas - November 14th, 2009
• Trading With Point And Figure Charts (Part I) - November 11th, 2009
• Is Your Real Estate Agent Knowledgeable? - November 11th, 2009