When You Find Yourself in a Hole, Stop Digging
Attributed to Will Rogers
Who knew that Will Rogers was a closet Risk Manager. He must have been because that is great risk management advise.
If you have too much of something – the first thing that you should do is to STOP ADDING to your position.
We do not yet have the full story, but it is pretty safe to guess that neither MF Global or JP Morgan followed that idea. It seems fairly obvious that at some point in time, the each had smaller positions that were already too big and then they ADDED to their positions.
The bank/hedge fund trading mentality suggests that the traders who really tener cojones will be able to keep raising the size of their position until the market breaks.
Insurance companies harbor the same mentality, except that they are never on the big win side of the bet. Insurers win small on any one bet. They win if there is no claim. But even with that lopsided situation does not stop insurers from loading up on bets where they already have too much.
So the answer is to invite WIll Rogers into your Limit protocol. When you are setting or reviewing your limits for the next period, set a new WILL ROGERS LIMIT. The new WILL ROGERS LIMIT (WRL) is the point where you automatically stop adding to your position if there has not been a discussion and an exception to the WRL.
And that is what risk management is all about. Just thinking ahead. It is not magic. Just listening to the great risk managers of the past.