Welcome back to the brewing trades podcast. I'm Sam, and you're listening to episode two today. We're diving into a critical topic for anyone involved in futures, Forex, or any leveraged trading markets, risk budgeting, whether you're a seasoned trader or just starting out, understanding how to allocate and manage your risk is essential for both protecting your capital and maximizing longterm growth.

In this episode. Our conversation focuses on the tools and techniques of risk budget. Our hosts, Maya and Remus, will be exploring various models. From volatility control to draw down limits and leverage adjustments. They'll break down how these strategies can keep a portfolio resilient through market ups and down discuss practical applications and share insights into avoiding common pitfalls.

So grab a coffee, settle in and get ready for an in depth conversation about managing risk and maximizing returns in the ever evolving world of trading. Let's get started. Let's get. 

Welcome back to the Deep Dive, ready to tackle risk management. Today, it's futures and forex, but with a twist. You guys have been asking for a deep dive into risk budgeting, so that's what we're serving up.

You got it. 

We've got insights from a YouTube trading expert, a research paper that gets into the institutional investor strategies. It's going to be a good one. 

Sounds good to me. 

All right, let's dive in. Let's do it. This YouTube trader, right off the bat, He's not just talking about winning or losing trades.

He's going deeper. It's the magnitude of those wins and losses that really makes the difference. 

Totally, yeah. You can't just be counting wins, right? You can have more winning trades than losers and still lose money if your losses are bigger than your wins. It's about the overall picture. 

He uses this term R multiple, which sounds kind of technical at first.

Mm hmm. But when you break it down, it's a pretty simple concept. 

Absolutely. It's basically how much you win on average compared to how much you lose. So if you win a hundred bucks on average and lose 50 on average, that's an arm multiple of two. You're making twice as much on your wins as you are losing on those losses.

So even if you're not winning every single trade, having a good R multiple can swing things in your favor. 

Exactly. It's so important, and a lot of new traders miss that. 

He's also super big on tracking every single trade, even if it's in a basic spreadsheet. Why is that so important? 

Data. Data. Data. It's king in trading.

By tracking everything, you see your strength, you see your weaknesses, you get to know your own trading style. You start to spot those patterns and refine your strategy. 

It's like having a journal, revealing all your hidden habits. 

Exactly. Without that data, you're just guessing. 

And then he lays out three ways to approach risk management.

Improve win rate, improve R multiple, or do both. 

It's a great framework. Ideally, you improve both, of course. Yeah. But even focusing on one can really boost your performance. 

From your experience, which of those paths is easier for most traders to really get a handle on? 

It really depends on the person and how they trade.

Some folks are naturals at finding those high probability trades. Others are better at managing trades once they're in, letting the winners run. It's all about playing to your strengths. 

This one surprised me. He actually suggested taking fewer trades to get that win rate up. Doesn't that seem a little counterintuitive?

It's about quality over quantity. When you're more picky waiting for the perfect setups, you're less likely to jump into those impulsive trades that can really hurt you. 

Like a sniper, waiting for that perfect shot. 

Exactly. Precision and discipline are key. 

He also emphasizes sticking with your strategy.

Don't just throw it out after a few losses. Tweak it, refine it. 

So many traders give up too quickly. They jump between systems without giving any of them a real chance to work. A few tweaks can make all the 

tweaks are we talking about here? 

Could be adjusting your entry and exit points, maybe refining your risk management rules, adding another filter to your criteria.

It's about those small adjustments that add up to big results. 

So it's constant refinement, always optimizing. 

Exactly. 

Now, he also mentioned that futures trading, please It gives you a clearer picture of risk and reward compared to options. 

Definitely. With futures, the payoff is directly linked to the price of the asset.

Makes it way easier to calculate potential profit and loss, so you can manage your risk much better. 

Options, they bring in all these extra complexities, time decay, implied volatility. 

Yeah, those can make it tough to figure out your risk, especially if you're new to it all. 

So for traders who really value that transparency and want things straightforward, Futures might be a good fit.

Absolutely. You got to find the instruments that suit you and your risk tolerance. 

And to maximize those profits, he talks about scaling into and out of positions, multiple profit targets, moving that stop loss to break even as the trade moves in your favor. 

That's a more advanced technique, but a good one.

You're locking in profits while still letting those winning trades run. 

Striking that balance between securing profits and letting things grow. 

Exactly. Po's use it all the time. 

Okay, let's switch gears for a minute. Let's talk about this research paper. It gets into those risk budgeting models that institutional investors use.

Yeah, these models can seem kind of intimidating at first glance, but they're basically frameworks for spreading your risk out strategically. 

It focuses on three main models. Volatility control. drawdown limit, and leverage control. Can you break those down for us? 

Sure. Let's start with volatility control.

This one's all about adjusting your position sizes based on how much you expect an asset to move around. Less money on the volatile stuff, more on steadier stuff. 

So it's all about smoothing out the ride, balancing out that risk exposure. 

Exactly. It helps create a more consistent return. Then you've got the drawdown limit model.

This one sounds a bit more serious. 

It is, in a way. It's all about setting a hard limit on how much you're willing to lose on a single trade or investment. Think of it as an emergency 

brake. So it's there to prevent those huge losses that 

could wipe you out. Right. Especially important in leverage markets like futures and forex.

And lastly, leverage control. I'm guessing this is all about managing that borrowed money. 

You got it. You adjust your position sizes based on how much leverage you're using. More leverage, smaller position sizes to keep that risk in check. 

Leverage is a powerful tool. But it can cut both ways. 

Definitely.

You got to use it responsibly. 

Now they did a bunch of simulations and bag testing with these models. What do they find? 

All three models, the volatility control, the drawdown limit, and the leverage control, they all performed way better than not using any risk budgeting at all. 

So no matter which model you pick.

Having some form of risk budgeting is better than nothing. 

Absolutely. Managing your risk actively makes a huge difference. 

The paper also has this really cool case study. It puts these concepts into action. 

Oh yeah, this one's a great example. It looks at a forex account using the drawdown limit model during a major currency devaluation.

Shows you how these models work in the real world when things get chaotic. 

Okay, so high stakes situation. Perfect for testing out a model. What happened? 

It's pretty amazing. The account using that dry down limit, it had 30 percent lower losses compared to a similar account that wasn't using any risk budgeting at all.

30%. That's a huge difference. Imagine what that means for your capital in the long run. 

Right. It shows you how important it is to have a plan in place for limiting your losses, especially when things get wild in the markets. 

So it's not just about protecting yourself from those crazy black swan events.

It's about navigating the day to day ups and downs as well. 

Exactly. Consistent risk management helps you ride those waves and stay in the game for the long haul. 

It's clear from both this YouTube expert's advice and what the research paper found, there's a lot of ways to approach risk management in futures and forex trading.

And the cool thing is, you don't have to just pick one model. The research actually suggests using a hybrid approach. You take bits and pieces from different models and create your own custom risk management framework. So 

drawdown limit as your main safety net. And then also use volatility control to fine tune your positions based on market conditions.

That's a great example. It's all about tailoring it to your needs and how much risk you're comfortable with. 

It's like having a toolbox full of tools for managing risk. You pick the right one for the job. 

Exactly. 

The paper also talks about dynamic allocation. It's not just about setting your risk budget once and forgetting it.

You've got to adjust it regularly. 

That's so important. Your risk budget shouldn't be static. It needs to adapt as market conditions change and as you get more experience as a trader. 

So if things are super volatile, maybe you dial back the risk a bit. But if things are calm, you could potentially size up your positions.

Exactly. You've got to stay responsive to the market. It's always changing. 

They also have a section on integrating risk budgeting models with automated trading systems. 

Now that's where things get really interesting. Automated systems take the emotion out of trading. They make sure you're always sticking to your risk management rules no matter what's happening in the markets.

Plus, they can handle so much data in real time. You get much more precise and responsive risk adjustments. 

Like having a super smart trading assistant constantly watching your back. 

Now, it's important to remember, these risk budgeting models are powerful. But they're not perfect. 

You can't predict the future with 100 percent accuracy.

And just because something worked in the past doesn't mean it's guaranteed to work again. 

The paper specifically mentions that those volatility based models, they might not work as well during those crazy black swan events, those things that nobody saw coming. 

Right. We always have to be aware of the limitations of any model.

And be ready to adjust our approach if needed. 

Sounds like it's all about finding that balance. You rely on the data and the models, but you also stay flexible enough to adapt when the unexpected happens. 

Exactly. Using the models as powerful tools, but recognizing that we still need to be able to think on our feet.

They also mentioned something about incorporating machine learning into these models. That sounds pretty futuristic. 

It's exciting, right? Imagine models that are constantly learning and evolving, adjusting their risk parameters based on the newest data and how you trade. 

That's like next level risk management.

It's a field with so much potential. It's going to be really interesting to see how it develops. 

So for our listener who's ready to start using these risk budgeting ideas. Yeah. In forex trading, what are the big takeaways? What should they focus on? 

The biggest thing, risk management is not optional. If you want to be successful in these markets in the long run.

You have to manage your risk. It's got to be part of your trading plan from day one. 

It's a lesson that a lot of new traders learn the hard way, right? 

Unfortunately, yeah. And don't be afraid to experiment with different models. Try that hybrid approach we talked about. Find what works best for you and your level of risk tolerance.

Customization is key. 

Absolutely. And remember, your risk budget needs to be flexible, adjusted as needed. The markets are constantly changing. Makes sense. 

Any last words of wisdom? 

Embrace the power of automation. Find a platform or software that can implement your risk management rules automatically. It takes the emotion out of it and makes sure you're consistent.

Great advice. Risk management, it might not be the most glamorous part of trading, but it's probably the most important. 

It's the foundation of everything. It's how you build consistent profits and a trading career that lasts. 

I couldn't have said it better myself. Now, there's one more thing the paper touches on.

The bigger implications of risk budgeting, especially for institutions and regulators. They even talk about how it could affect policy. I know we're mainly focusing on the individual trader here, but I'm curious to hear your thoughts on this bigger picture. 

Yeah, it's interesting to think about how these ideas we're talking about, how they can impact the whole financial system, not just individual traders.

Right. The paper argues that if more institutions like banks and hedge funds were using these risk budgeting models. It could actually make the whole system more stable. 

Exactly, especially in those markets where there's a lot of leverage. Imagine if everyone was managing their risk more carefully. It could potentially prevent those big meltdowns like we saw back in 2008.

It makes you realize that risk management It's not just about protecting yourself, it's about contributing to a healthier financial system overall. 

It all connects. Responsible risk management at every level makes a difference. 

Before we move on, I wanted to circle back to something we talked about earlier.

The paper actually encourages traders to think about using a hybrid approach, combining elements from different risk budgeting models. 

Yeah, it doesn't have to be one or the other. You can pick and choose what works best for you. You create your own custom system. 

So you might start with a maximum drawdown limit, like we talked about, as your main safeguard.

But then you could also layer in some volatility control to adjust your position sizes based on how the market is behaving. 

Exactly. It's all about finding the right combination of tools for the job. 

And they also emphasize that your risk budget is not something you just set once and forget about. You gotta be flexible.

Right. The market is always changing. You have to adjust your risk budget as those conditions change and as you learn and grow as a trader. 

So you're constantly evaluating, making adjustments, staying on top of things. 

Exactly. It's an ongoing process. 

They also have a whole section on using automation to manage risk.

Yeah. That's super powerful. With automated systems, you're not letting emotions get in the way. You're sticking to your rules no matter what. 

And they can handle so much more data, which means you can fine tune those risk adjustments in real time. 

It's like having a co pilot who's always looking out for you.

Now, it's important to acknowledge that these risk budgeting models, as cool as they are, they're not perfect. 

Of course not. No model can predict the future perfectly. 

And the paper points out that some models Especially those based on volatility, they might struggle when you have those really unexpected events, those black swans that nobody saw coming.

That's right. You have to be aware of the limitations and be ready to adapt if things don't go as planned. 

So it's about having the right tools, but also having the flexibility to think for yourself and make adjustments when necessary. 

Exactly. It's a balance between using the data and using your own judgment.

One thing that really caught my eye, the paper suggests that in the future, we might see machine learning being integrated into these risk budgeting models. 

Oh yeah, that's a fascinating idea. Imagine models that are constantly learning and evolving, getting smarter all the time. 

That's like risk management on autopilot.

It's definitely an area to watch. There's a lot of potential there. 

So for our listeners who are ready to take action and start implementing these ideas in their own trading, What are the key things they should focus on? 

First and foremost, make risk management a non negotiable part of your trading. It's not an afterthought, it's the foundation of everything.

And I think a lot of new traders, they learn that the hard way. 

Yeah, it's a common mistake. And don't be afraid to experiment. Try different models, try that hybrid approach. Find what works best for you. 

Customize it to fit your needs. 

Exactly. And remember, be flexible. Adjust your risk budget as the market changes.

Makes sense. 

Yeah, embrace automation. Use the technology that's available to help you stay consistent and take the emotion out of it. 

Great advice. Risk management. It might not be the most exciting part of trading. But it's definitely one of the most important. 

It's how you build a sustainable career as a trader.

Absolutely. Now there's one more thing I wanted to touch on. The paper talks about how risk budgeting has implications beyond just individual traders. It talks about institutions, regulators, and even the potential impact on policy. I'm curious to get your take on that bigger picture. 

Yeah, it's a pretty big idea.

The paper basically argues that if more of those big institutions like banks and hedge funds were using these sophisticated risk budgeting models, the whole financial system could actually become more stable. 

So kind of like a ripple effect. 

Right. Exactly. 

Yeah. 

Because when those institutions manage their risk effectively.

It has a knock on effect throughout the entire system, especially in those leveraged markets where things can move really fast. 

Makes sense. It's like, if the big players are playing it safe, it creates a safer environment for everyone else. 

Exactly. And it could potentially help prevent those massive financial crises that can really shake things up.

We've seen how that can happen, for sure. 

Right. It's a reminder that risk management is not just about protecting yourself. It's also about contributing to the overall health of the financial system. 

It's kind of like a shared responsibility. 

Exactly. We all have a role to play. 

Before we wrap up, I wanted to touch on one more interesting idea from the paper.

It mentions expanding these risk budgeting approaches beyond just futures and Forex. They talk about using them for other assets, too, like commodities, equities, even cryptocurrencies. 

That's a cool idea, right? Taking those core principles of risk management and applying them to basically any type of investment.

So instead of having different approaches for different asset classes, you could have one overarching framework for managing risk across your entire portfolio. 

It would be interesting to see how those models perform in those different markets, each with their own unique risks and characteristics.

That's a pretty big idea. Yeah. But it shows how versatile these risk budgeting models can be. It's not just about specific markets, it's about a whole new way of thinking about risk. 

It's a challenge to researchers and traders to really explore those possibilities. To see how we can use these ideas to create a more resilient and stable financial future.

Well, I think we've covered a lot of ground today. From those practical tips from the YouTube trader, to those sophisticated models used by institutions, to And even those broader policy implications. 

Hopefully our listeners are feeling inspired to take the risk management to a whole new level.

Absolutely. And remember, you don't have to become an expert overnight. Just start by incorporating some of these key principles into your trading plan. 

Exactly. Start small, stay consistent, and always prioritize protecting your capital. 

So as you continue on your trading journey, think about this. If you could consistently limit your losses but still let those winning trades run, what kind of impact would that have on your results?

It's a question worth pondering. 

That's the real power of risk budgeting. It's not just about avoiding losses. It's about creating a system that gives you the confidence to trade knowing you're prepared for whatever the market throws at you. 

I love that. Great note to end on. Thanks for joining us on this deep dive into the fascinating world of risk budgeting.

It's been a pleasure. Until next time, happy trading, and remember, manage your risk and let those profits run. 

And that brings us to the end of today's episode of the Brewing Trades Podcast. I hope you found this conversation on risk budgeting both insightful and informative. We covered a lot of ground for volatility control to drawdown limits and leverage management.

Essential tools for anyone looking to trade smarter, not harder. As always, remember that trading is about discipline and planning, and risk budgeting can be the backbone of a successful strategy. Whether you're protecting against drawdowns or aiming for a win, For consistent returns. Taking the time to plan your approach can make all the difference.

If you enjoyed today's discussion, make sure to subscribe and leave a review. And if there's a specific topic you'd like us to cover in future episodes, feel free to reach out. Thanks for joining us, and until next time, trade wisely. Stay curious and keep brewing those trades.