Book Review: The Risk of Trading by Michael Toma

I recently finished another audiobook so I figured I might as well write this review while the book is still fresh in my mind. "The Risk of Trading: Mastering the Most Important Element in Financial Speculation" by Michael Toma admittedly started off as a dry read.I honestly thought that this was another one of those books with an emphasis on the 2% risk per trade rule along with using stop losses, etc. The book started off a bit dry highlighting the various risks associated with trading, but it did provide some useful insights. I probably gained a full appreciation for this book once I finished reading it.

Before we go any further, I should probably mention that my goal has always been to have one takeaway after reading/listening to a book. Since I segmented my sessions across multiple days, some of the earlier concepts may not stick out anymore. By always having one takeaway from each book that I read, this is an opportunity for me to go back, re-read, and get another takeaway. For books that take time for me to appreciate their value, I always make an effort to go back and re-read when time permits.

Before we jump into my three takeaways, feel free to click this link and bookmark it. This is the book's accompanying PDF, in which Audible decided that an obfuscated URL is sufficient.

Takeaway #1: Reward to risk ratios can't be looked at in isolation.

The takeaway is largely the rant I made previously about how traders claim that you should only take setups if it generates a ratio of 3:1 or more. Michael Toma used an example, which I think is simpler than mine. Here's why the whole reward to risk concept used in isolation is problematic. I think this example is one where everybody subconsciously understands, but fails to apply it to their trading.

Let's say you're betting on a coin flip, where you win $1 every time the coin lands on heads. What's the maximum amount that you're willing to put down in order to play this game?

Chances are, the amount that you're thinking of does not exceed $1. Subconsciously, you know that the odds of a coin landing on heads is 50%. Yes, the coin could land on tails 10 times in a row. However, you know that the long term expectancy is 50%. If you keep betting $0.99, your reward to risk ratio is effective 1.0101. You also know that your win rate is 50% or 1:1. If you compare these two stats, you would always want to participate by betting $0.99 with a chance of winning $1.

Michael Toma mentioned several other risk management examples, but this one, by far, stuck out to me the most. Admittedly, I'm not a very mathematical or quantitative person by nature. If I took a textbook approach in learning these risk metrics, they would never stick to me. I learn by application so I will need to slowly incorporate them into my own trading. This leads to my second takeaway.

Takeaway #2: Data-Driven Trade Talk

"Data-Driven Trade Talk" is one of the headers of the windows in the accompanying PDF. This is one of my flaws and I recognize that I am guilty of this. My responses tend to be non-quantitative. I'm beginning to see that this is problematic because it takes away from you're measuring your performance by opinion, not by the actual trade statistics generated with your transaction history.

For example, as humans, we are prone to glorify successes and mask pain. Consequently, this means that we're likely to overemphasize our profits and dull our losses. You'll never get a true picture of your performance until you start taking an objective approach. This PDF outlines a better approach to answering trading performance related questions. I highly recommend keeping it open and being aware of how you're responding to your trading performance.

Takeaway #3: SWOT Analysis

This blew my freaking mind. I would've never thought to perform a SWOT analysis on myself prior to reading this book. I think every trader should be performing this analysis on a regular basis. The objective of this is basically to gain a better understanding of yourself. Table 8.4 in the PDF provides an example SWOT analysis performed. You'll notice that some non-trading related factors have been included as well. By completing one of these, I do believe that one will be able to have a more objective assessment of their trading, financial, and personal situation. For the sake of keeping this post relevant to the book, I will save my own SWOT analysis for a later post.