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Portfolio Management and Risk Management Philosophy

There are Seven major precepts underlying my approach to portfolio management and risk management challenges. Includes comments on the application of Sun Tzu and The Art of War to portfolio management and risk management.


They include comments on our philosophy about analyzing and trading the capital markets for portfolio management and risk management purposes and are organized by the following sections:

Risk Management - Inherent need for portfolio managers and risk managers to focus on the understanding and management of risk.

Nothing New! Either in these comments or in any experience that might be encountered in trading any market or instrument

Knowledge - Acquisition of knowledge through study, observation, and experience; organization of information to facilitate rational analysis; and, wise application.

Why Philosophy - Why emphasize portfolio management and risk management philosophy over trade selection and trading systems?

Forecasting Dilemma - Age-old dilemma (and resolution) associated with the need to forecast future events.

Balance - Balancing intuitive and computerized trading. As in most activities, balance is critical to achieving and maintaining success.

Management War - Portfolio and risk management war effectively results in the transfer of wealth from the many to the few. Includes discussion on the application of Sun Tzu and The Art of War to portfolio management and risk management.

Risk Management

Regardless of how the portfolio management and risk management activity is characterized, e.g., investing, trading, speculating, or hedging; regardless of the markets and instruments traded; and, regardless of the strategies and tactics employed; one requirement is common to all applications - the need to understand and manage the risk inherent in the underlying activity. All analytical and decision making and implementation processes are oriented to making sure that risk can be prudently managed before focusing on the potential reward.

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Nothing New

The most fundamental premise of my portfolio management and risk management philosophy is that there is absolutely nothing new, either in these comments or in any experience that might be encountered in trading any market or instrument.

Quote from Ecclesiastes 1:9,10 (NIV):

"What has been will be again, what has been done will be done again; there is nothing new under the sun.

Is there anything of which one can say, 'Look! This is something new'? It was here already, long ago; it was here before our time."

Granted, each of us is continually experiencing challenges that are new to us as individuals, and technological advancements continue to improve and accelerate our ability to perform functional tasks. However, the substance of the functional tasks have remained the same. Heraclitus probably said it best:

"The more things change, the more they remain the same."

Both of these quotes were already timeless and old when penned; Ecclesiastes, possibly by Solomon around 3,000 years ago, and Heraclitus around 2500 years ago. How much more appropriate in today's fast paced environment?

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Study, Observe, Remember, Compare, and Apply

Knowledge is very critical to successful portfolio management and risk management. However, in and of itself, unemployed knowledge is of limited utility. The key is in being able to acquire knowledge through study, observations, and experience; organize the resulting information in such a way as to facilitate rational analysis; and, then being able to apply it wisely and with understanding in consistently creating profitable results from portfolio management and risk management situations on an on-going basis.


The key to developing a pragmatic understanding of preparing for the future is to diligently study and receive wise and knowledgeable instruction regarding the past.

Quote from Proverbs 3:19-20 (NIV):

"By wisdom the Lord laid the earth's foundations, by understanding he set the heavens in place; by his knowledge the deeps were divided, and the clouds let drop the dew."

Quote from Proverbs 4:7 (NIV):

"Wisdom is supreme; therefore get wisdom. Though it cost all you have, get understanding."

Quote from Proverbs 4:13 (NIV):

"Hold on to instruction, do not let it go; guard it well for it is your life."


Be consciously observant of all things, past and present, at all times.


Organize and store the information and events observed in such a way as to facilitate timely recall and analysis.


Systematically analyze and compare observed information and events to one another to develop relationship correlations and event probabilities. Also, compare the current situation to results of historic analytics to determine suitability of strategies and tactics to current situation.


Apply the results of the analysis to selecting, implementing, and managing suitable strategies and tactics. The objective, of which, is to continuously improve portfolio management and risk management performance.

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Why Emphasize Philosophy?

Why do we put so much emphasis on portfolio management and risk management philosophy and not trade selection and trading systems?

Fiber That Holds Portfolio Management and Risk Management Process Together

My portfolio management and risk management philosophy is the fiber that holds the elements and substance of my portfolio management and risk management approach together regardless of the nature of the immediate circumstances; whether they be prosperous or poor, favorable or unfavorable, difficult or easy.

Quote from Edwards and Magee's Technical Analysis of Stock Trends, pg., 428:

"The fact is, however, that many traders, not having set up a basic strategy and having no sound philosophy of what the market is doing and why, are at the mercy of every panic, boom, rumor, tip, in fact of every wind that blows."

Additional quote from Edwards and Magee's Technical Analysis of Stock Trends, pg., 287:

"In short, the problem stated and analyzed through this whole volume is not so much a matter of 'systems' as it is a matter of philosophy. The end-result of your work in technical analysis (JDH note: any form of market analysis) is a deep understanding of what is going on in the competitive free auction, what is the mechanism of this auction, and what is the meaning of it all. And this philosophy does not grow on trees. It does not spring full-bodied from the sea-foam. It comes gradually from experience and from sincere, intelligent hard work."

Framework Of Principled Guidelines

Furthermore, in addition to being the fiber that holds my portfolio management and risk management approach together, my philosophy provides a framework of principled guidelines within which meaningful work can take place and, in turn, provides a foundation upon which significant portfolio management and risk management accomplishments can be achieved.

Quote from Edwards and Magee's Technical Analysis of Stock Trends, pg., 285, in referring to comments made by James Bryant Conant, president emeritus of Harvard University:

"Dr. Conant points out that in school we learn that science is a systematic collection of facts, which are then classified in orderly array, broken down, analyzed, examined, synthesized and pondered; and then lo! a Great Principle emerges, pat, perfect, and ready for use in industry, medicine, or what-have-you. He further points out that all of this is a mistaken point of view which is held by most laymen. That discovery takes form little by little, shrouded in questioning, and only gradually assumes the substance of a clear, precise, well-supported Theory. The neat tabulation of basic data, forming a series of proofs and checks, does not come at the start, but much later. In fact it may be the work of other men entirely, men who, being furnished with the conclusions, are then able to construct a complete integrated body of evidence. Theories of market action are not conceived in a flash of inspiration. They are built, step by step, out of the experience of traders and students, to explain the typical phenomena that appear over and over again through the years."

Focus Of Philosophy

The constant focus of my portfolio management and risk management philosophy is the enablement of sound strategic and tactical judgments and the minimization of the inevitable risks associated with haphazard judgments. Therefore, the crux of the foregoing comments on portfolio management and risk management philosophy is that the framework of principled guidelines, while it may seem inhibiting to some (primarily the undisciplined), in reality provides a constructive means of extraordinary portfolio management and risk management accomplishment and expression through disciplined and intelligent inquiry into market conditions (phase, section, pattern, swing, volatility).

Quote from Alan Watts' Tao--The Watercourse Way:

"The same is true in music, painting, and cookery, for Lao-tzu says;

The five colors blind one's eyes;
The five tones deafen one's ears;
The five tastes ruin one's palate.

He is, of course, referring to the formal rules and classifications for these arts, as to say that if you think there are only five colors, you must be blind, and deaf if you think that all music has to be in the pentatonic scale. This is, alas, the reason why schools for these various arts produce so few geniuses, and why the genius--the person of te--is always going beyond the rules, not because of an obstreperous and antisocial spirit with hostile intent, but because the fountain of creative work is an intelligent questioning of the rules."

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Forecasting Dilemma

In portfolio management and risk management, one of the most perplexing dilemmas stems from the need to forecast future price, rate, and/or volatility movement vs. the inability, of most traders, to do so accurately and on a consistent basis. More specifically, virtually every strategy that can be implemented has, at minimum, an implied bias of expected future price, rate, and/or volatility movement, regardless of the trader's inclination to make an explicit forecast. The dilemma develops from the following points as they relate to the need to forecast:

Risk Avoidance vs. Risk Management

Many traders try to avoid the issue of having to make an explicit forecast due to fear of the risks associated with the forecast being wrong. What they fail to recognize is;

Implied Forecast

Doing nothing (taking no action, failure to make an explicit forecast) has risk, and, at minimum, defaults to an implied forecast of future events.

Risk/Reward Relationship

Without risk (and prudent risk management), there is no reward.

Performance Profile

Few, if any strategies, have a performance profile that is profitable in all price, rate, and volatility scenarios.


Even though one strategy does not fit all price, rate, and volatility scenarios, a suitable strategy and tactic set can be developed, implemented, and managed for most market environments.

Quote from Ecclesiastes 3:1-8 (NIV):

"There is a time for everything, and a season for every activity under heaven:

a time to be born and a time to die,
a time to plant and a time to uproot,
a time to kill and a time to heal,
a time to tear down and a time to build,
a time to weep and a time to laugh,
a time to mourn and a time to dance,
a time to scatter stones and a time to gather them,
a time to embrace and a time to refrain,
a time to search and a time to give up,
a time to keep and a time to throw away,
a time to tear and a time to mend,
a time to be silent and a time to speak,
a time to love and a time to hate,
a time for war and a time for peace."

Therefore, the real challenge is to determine which portfolio management and risk management Strategies & Tactics are suitable to current market conditions, and future market conditions under which risk exposure levels would be unacceptably high.

Imbedded Bias

The performance profile of each strategy, when charted beforehand, will reveal the price, rate, and/or volatility bias imbedded in the strategy, thereby, revealing its suitability to portfolio management and risk management objectives.

Ability To Forecast

Very few traders, if any, have demonstrated the ability to accurately and consistently forecast future price, rate, and volatility movements (not to mention the ability to profit from the forecasts even when correct); however,


As important as an accurate forecast is to the eventual success of a strategy, it is even more important for the trader to maintain the emotional and financial flexibility to adapt strategies and tactics to the realities of current price, rate, and volatility conditions; therefore,

Trader's Focus

The trader's focus needs to be on maintaining the financial and emotional ability to adapt strategies and tactics, within a principled framework, rather than being paralyzed by the perceived risks of the forecast being wrong.

Hedger's Emotional Attachment

For hedgers, an additional element surfaces, wherein, an emotional attachment tends to develop around the need for the hedge strategy to be profitable on the hedge side. Notwithstanding the obvious abrogation of basic hedge principles, and despite the flawed logic of this position, i.e., few hedgers (especially this type) hedge 100% of their portfolio. Therefore, to unduly emphasize the profitability of the hedge side of the strategy is to say that the loss on the unhedged portion of their portfolio is less consequential than showing a profit on their hedge positions. Obviously, this is a very weak position. However, for most hedgers, it is simply a fact of life.

Paradoxically, this puts an even greater weight on the need to forecast and further exacerbates the negative consequence of being wrong. Which, in turn, further encourages the trader to avoid the risks of explicit forecasts by accepting the risks of doing nothing.

Forecasting Dilemma Resolution

My resolution of the forecasting dilemma is based on the premise that it is possible to be wrong in our forecasts part of the time (simply being human assures us of this), and still be successful portfolio managers and risk managers on balance. To do this, it is necessary to have a background of focused knowledge and experience sufficient to know what will usually happen under particular conditions, about how often the unexpected will occur, and how to deal with the unexpected when it does happen. Additional points of this resolution include;

Separate Risk Exposure From Market Forecasting

The analysis of the risk exposure inherent in a portfolio position is distinctly different from developing a market forecast. The first leads to a statement that expresses the directional price, interest rate, or exchange rate movement to which the portfolio is exposed, regardless of where the portfolio manager or risk manager thinks the market is headed. Additionally, the first is a current condition that is a result of past portfolio management and risk management actions. The focus is on the portfolio's "as is" performance profile. The second leads to a statement that expresses the portfolio manager's or risk manager's forecast of future market conditions, regardless of the directional risk exposure inherent in the current portfolio. The focus is on the market. Both issues are important. However, most people tend to commingle the two issues as one, which oftentimes exacerbates, rather than ameliorates the risk exposure inherent in the portfolio. A common occurrence in this regard is when the portfolio manager or risk manager develops a strong emotional attachment to a directional market forecast that, in turn, leads to the development and implementation of a strategy that benefits from the forecast, but, may or may not be consistent with the underlying portfolio management and risk management objectives (assuming they have been articulated). Therefore, we need to clearly separate the need for, and the analytics associated with, properly analyzing and understanding the risks inherent in the existing position (i.e. the imbedded, or implicit, forecast revealed by the "as is" performance profile), from the need for, and the analytics associated with, developing a forecast of future events.

Objective Analytic Framework

Have an objective analytic framework within which market conditions (phase, section, patterns, swings, and volatility) can be cataloged, probabilities developed, and action taken. In addition to improving conscious decision making, this discipline has a positive impact on the trader's reasoning ability and the instinctive, or intuitive, ability to process information in a timely and useful manner.

Iterative Portfolio Management and Risk Management Process

Portfolio management and risk management will be on-going processes for as long as there is a portfolio to be managed. These are not one-time events or decisions. Therefore, we need to consciously address, on an on-going basis, the main components of an iterative portfolio management and risk management process;

* Analytic methodology,
* Conclusions (assessments and forecasts) resulting from analysis,
* Strategy development and implementation resulting from assessments and forecasts,
* Tactical actions (positions) taken as a result of changing market conditions after strategy initiation, and,
* Price, rate, and/or volatility bias inherent in portfolio composition, strategic and tactical actions, and market positions (non-positions).

Explicit Acknowledgment Of Forecast

Explicitly acknowledge the forecast implied within an existing portfolio position, the forecast resulting from our market analysis, and the price, rate, and/or volatility bias inherent in each strategy and tactical adjustment.

Tactical Provisions To Adapt

Include in each strategy, tactical provisions to promptly manage the risk of the forecast being wrong, by iterating through each step of the aforementioned process, thereby, dynamically linking probabilistic forecasts to strategies and related tactics.

Emotional Need To Prove Forecast Right

Constantly be on guard against becoming emotionally attached to the need to prove a forecast right. This usually results from making a forecast public, then feeling emotionally compelled to defend the forecast, especially when it proves to be wrong.

What Portfolio Managers and Risk Managers Are Paid To Do

Portfolio managers and risk managers get paid to be a successful portfolio managers and risk managers. They do not get paid to be a forecaster. Forecasts are simply a tool to be utilized in guiding our efforts in improving our ability to move the portfolio management and risk management process toward greater profitability. As important a tool as the forecast is, the rightness or wrongness of a forecast is always subservient to the performance results of the strategy and related tactical adjustments.

The Real Objective

The objective is to be successful, on balance, in achieving our portfolio management and risk management goals. The objective is not to consume resources proving the efficacy of a forecast. Therefore, keep all forecasts within the context of the portfolio management and risk management activity, thereby, minimizing the need to defend something that is not worth defending. The public has no need to know a portfolio manager's or risk manager's forecasts; and, the portfolio manager and risk manager do not need the emotional burden that goes along with defending public forecasts.

What Does Need To Be Defended?

If the public wants to know a portfolio manager's or risk manager's forecast(s), they can spend their own time and resources observing action(s) and examining position(s) to determine the imbedded bias, at that point in time. Portfolio management and risk management action(s) and position(s) are all we need to be prepared to defend, because that is where the money is made or lost.

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Balancing Intuitive and Computerized Trading

The challenge is to combine the benefits of two very powerful tools, i.e., the intuitive adaptability of the human brain and the massive information processing, storage, and communication capabilities of modern computer and telecommunication technology; while, at the same time, minimizing the negative effects of whimsical human emotional changes and the inflexibility of static computer programs.

Analysis Versus Intuition

For an excellent qualitative and quantitative treatment of analysis versus intuition, as applied to financial markets, see Prof. Lester Ingber's archives for a series of papers, some viewable as a series of .gif files. Prof. Ingber gives motivation and detailed techniques for developing sophisticated nonlinear multivariate analyses into intuitive technical indicators that can be used by decision makers for financial applications. He states:

"Too often the management of complex systems is ill-served by not utilizing the best tools available. For example, requirements set by decision-makers often are not formulated in the same language as constructs formulated by powerful mathematical formalisms, and so the products of analyses are not properly or maximally utilized, even if and when they come close to faithfully representing the powerful intuitions they are supposed to model. In turn, even powerful mathematical constructs are ill-served, especially when dealing with multivariate nonlinear complex systems, when these formalisms are butchered into quasi-linear approximations to satisfy constraints of numerical algorithms familiar to particular analysts, but which tend to destroy the power of the intuitive constructs developed by decision-makers. These problems are present in many disciplines including trading in financial markets. In this context, we can consider the trader as the decision maker on the nature of market data, sometimes also carrying the additional role of his or her own analyst."

Quality and Power of Subconscious

Focus on developing the ability to enhance quality and power of subconscious via organized input, without becoming mesmerized or overwhelmed by the inputting process or by the resulting output.

Quotes from Alan Watts' Tao--The Watercourse Way:

"The human organism has the same kind of innate intelligence as the ecosystems of nature, and the wisdom of the nerves and senses must be watched with patience and respect." pg., 119

"...make experiments in which what has been written is always subordinate to the observation of what is." pg., 119

"Speech and writing are undoubtedly marvelous, but for this very reason they have a hypnotic and fascinating quality which can lead to the neglect of nature itself until they become too much of a good thing. Thus when 'the rule of law' becomes absolutized and everything is done by the book or the computer, people call out in desperation for the intervention of a reasonable human being." pg., 120.


Refer to Felson material

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The Portfolio and Risk Management War

One of the primary results of portfolio managers and risk managers interacting in the capital markets is the reallocation of wealth from the many to the few. This wealth transfer process might well be called The Portfolio Management and Risk Management War. To be successful in this war, we must align our portfolio management and risk management efforts with the few rather than the many.

The few to whom the wealth is being transferred are those who have acquired and consistently apply, in a disciplined manner, focused portfolio management and risk management knowledge and experience. Therefore, the key to aligning ourselves with the few is to acquire and apply focused knowledge and experience in a consistent and disciplined manner.

In this effort, we must always recognize that there is no perfect approach to the market. Any approach is going to have strengths and weaknesses. What we are looking for is the probability inherent in each situation. Dealing with human imperfection is one of the most important psychological battles in the portfolio management and risk management war.

Around 2300 years ago, Sun Tzu is credited with having written The Art of War, a compilation of essays that might well be termed the concentrated essence of wisdom on the conduct of war. The attached file, Sun Tzu and The Art of War, contains some of the more salient quotes, drawn from THE ART OF WAR -- SUN TZU by James Clavell, along with my thoughts on companion Portfolio Management and Risk Management corollaries. I have also drawn several companion thoughts, as noted, from Samuel B. Griffith's translation of, and commentary on, the same work entitled, SUN TZU -- THE ART OF WAR.

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