For a profession that advocates stoicism, last week was certainly a roller-coaster ride. Here're my thoughts on how to find order in chaos:
First of all, respect fear. Fear is often talked about as a negative trait in trading; in reality, fear protects us. As last week proved, events that lie outside the normal probability distribution curve are improbable, not impossible. The collapse of LTCM spectacularly showed that neither genius nor size can necessarily survive anomalies. Defense really is the best offense, and capital preservation needs to take priority at all times.
Of course, all trading is risky by its very nature. Taking a cue from Donald Rumsfeld, I have broadly divided trading risks into 2 categories: Unknown-unknowns and known-unknowns.
Unknown-unknowns: No one can really mitigate the unknown-unknown kind of trading risk. Last Friday's RTC news and the ban on financial shorting were unknown-unknowns. There was simply no way to anticipate an outlier event like that - unless you had access to tomorrow's Wall Street Journal today.
Trying to trade based on unknown-unknowns is a pure gamble, without all the fun of Vegas.
Known-Unknowns: There are several known-unknowns in trading. For instance, we know about the earnings and conference dates, short-interest, new product introduction dates, etc.
Those can be accounted for while making buying and selling decisions. Also, the known-unknowns can be greatly reduced by disciplined investing, such as careful position sizing, stop-losses, diversification and careful adherence to those personal rules.
That brings me to my most important trading tenet: Consistently grow your account.
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