What is Trading? What is Risk Management?

Trading (and trade in general) in its true fundamental form is not about mathematics at all, not even one iota, but is basically about buying and selling, profit and loss. To calculate profit and loss, a knowledge of basic arithmetic is sufficient.

Its fundamental principle is to buy low and sell high, and not necessarily in that order. The complex mathematics of pricing and hedging is no more and no less than finding ways to achieve the above principle.

The truth about trading is exemplified in many excellent books. Reminisces of a Stock Operator has a number of trading strategies that work when the volatility is low.

However, allied with Trading is the role of Risk Management, which are more about how you can manage your trading activity in a mathematical way so that you can trade robustly regardless of external conditions.

The Realized Variance of Easter Eggs

The payoff of a variance swap is quite a different affair depending on who you are in the buying and selling process. Suppose I am a nasty speculator who thinks the spot market for Easter Eggs is going to go crazy and wants to be long realized variance on Easter Eggs. I don't care about Easter Eggs, I don't consume Easter Eggs, I just watch the prices like a hawk and see that things are going crazy.

Lots of people are buying and selling Easter Eggs and no-one, absolutely no-one, can agree a price. Why? The cost of cocoa, the cost of milk, the cost of sugar are all fluctuating wildly according to strange models like e=mc-squared.