Trading Process, Trade Construction & Risk Management QNA

What factors would you consider when forming a market view?

I’d combine top-down and bottom-up analysis, with the balance depending on the asset. Top-down, I’d look at growth, inflation, monetary and fiscal policy, the economic cycle and the broader market regime. Bottom-up, I’d look at the specific asset or issuer — fundamentals, valuation, supply and demand, balance-sheet or earnings risks where relevant, and any idiosyncratic factors. Then I’d ask what the market already prices, how investors are positioned, what related markets are signalling and what catalyst could change expectations. Finally, I’d define what would invalidate the view. CONTEXT / INTUITION: Rates and FX are usually more top-down because they are heavily driven by macro and relative policy; single-name equities and Credit usually require more bottom-up work. The key chain is: what drives this asset → what do I think → what does the market already think → what could make pricing change → what would prove me wrong.

How would you determine what is already priced in and whether an asset may be mispriced?

I’d first identify the expectations embedded in market prices. In Rates, OIS and short-rate futures can show the policy path being priced; yield curves, credit spreads, valuations and option prices can reveal other assumptions and risks. I’d compare those implied expectations with my own assessment of the fundamentals and probabilities, while looking at positioning and recent price action to understand how much of the narrative has already been absorbed. I’d call something mispriced only if I thought the probability, magnitude or market impact of an outcome differed meaningfully from what the current price implies. CONTEXT / INTUITION: “I expect good news” does not mean “I should buy”. If the market expects even better news, the asset can fall when your good outcome occurs. For example, expecting three cuts is actually hawkish if the market prices five. Trading is about your view relative to the price, not your view in isolation.

What is a catalyst, and why is it important to a trade?

A catalyst is an event or development that can cause investors to update their expectations and reprice an asset. It could be an inflation release, central-bank meeting, earnings announcement, election, government policy change or company-specific event. It matters because even if I think an asset is mispriced, that mispricing can persist for a long time without something that forces the market to reassess it. I’d therefore want to understand both why I think the market is wrong and what could cause that disagreement to close. CONTEXT / INTUITION: Thesis answers “why should this asset be worth something different?” Catalyst answers “why might the market realise that?” You can be fundamentally right but lose money if the catalyst arrives too late, the trade carries badly in the meantime or another risk overwhelms the thesis.

How would you use correlated markets to confirm or challenge a trade idea?

I’d look at other assets exposed to the same underlying driver and see whether they support the economic story behind my trade. For example, if I thought US growth was strengthening, I might examine Treasury yields, cyclical equities, credit spreads, commodities and the dollar. If those markets gave conflicting signals, I’d investigate the reason rather than automatically abandoning the trade. I would not assume historical correlations are permanent because relationships change across regimes; what matters is the economic mechanism connecting the markets. CONTEXT / INTUITION: Cross-asset confirmation is a diagnostic tool, not a rule. Equities rising while yields fall might seem inconsistent with stronger growth, but it could make sense if inflation is falling sharply and the market expects easier policy. Always ask why two assets should be correlated before relying on the correlation.

How do positioning and sentiment affect asset prices?

Prices depend not only on fundamentals but also on who already owns the asset, how large those positions are and what investors expect. If a bullish view is already extremely crowded, good news may have limited upside because much of the buying has already happened, while even a small disappointment can trigger a sharp unwind. Conversely, heavily shorted assets can rally violently if investors are forced to cover. I’d therefore use positioning and sentiment to judge asymmetry, crowding and the risk of squeezes or forced deleveraging. CONTEXT / INTUITION: Prices move because of marginal buying and selling. If nearly everyone who wants to own an asset already owns it, there may be very few new buyers left. This is why “good fundamentals” and “good trade” are not always the same thing.

How would you choose the best instrument or structure through which to express your view?

I’d choose the instrument whose P&L is most directly linked to the part of my thesis I actually have conviction in, while minimising unrelated risks. I’d compare liquidity, transaction costs, carry, leverage, basis risk, volatility exposure, time horizon and downside. For example, if I believed the Fed would cut more than markets price, receiving fixed in OIS or buying the appropriate short-rate future would usually be a cleaner expression than simply buying equities. If the direction was clear but timing or event risk was uncertain, an option might be better because it can provide convexity and defined downside. CONTEXT / INTUITION: Being right about the macro story is not enough if the instrument introduces risks your thesis says nothing about. The best trade expression isolates the disagreement between you and the market as cleanly as possible.

What is the bid–ask spread, and what causes it to widen or tighten?

The bid–ask spread is the difference between the best available price to buy and the best available price to sell. For someone demanding immediate liquidity, crossing that spread is part of the transaction cost. Spreads tend to be tighter when markets are liquid, competition between liquidity providers is strong and volatility and information risk are low. They widen when volatility rises, market depth falls, inventory becomes harder to manage or dealers face greater adverse-selection risk. CONTEXT / INTUITION: A market maker earns compensation for providing immediacy but takes the risk that the price moves before the position can be hedged or that the person trading against them is better informed. Around major data releases, those risks increase, so spreads often widen. (CME Group)

How does liquidity affect your ability to enter and exit a position?

Liquidity is the ability to trade meaningful size quickly without causing a large price movement or incurring excessive cost. I’d look not only at volume, but also bid–ask spread, market depth, size available at different prices and expected market impact. In a liquid market I can generally enter or exit with tighter spreads and less slippage; in an illiquid market, my own trade may move the price materially. I’d also remember that liquidity is state-dependent and can disappear during stress, when everyone tries to exit at the same time. CONTEXT / INTUITION: An asset can look liquid when markets are calm because small trades execute easily, but the real test is whether you can exit your actual position size during stress. That is why position size and liquidity should always be considered together. (CME Group)

What is the difference between market, limit and stop orders?

A market order prioritises immediate execution and trades against available liquidity at the best prices currently offered, so execution is likely but the exact price is not guaranteed. A limit order sets the worst price I’m willing to accept — the maximum for a buy or minimum for a sell — so it provides price protection but may not execute. A stop order becomes active when a specified trigger level is reached; a standard stop-market order then becomes a market order, so its eventual execution price can be significantly worse than the stop level in a fast or gapping market. CONTEXT / INTUITION: Market order = prioritise execution. Limit order = prioritise price. Stop-market order = trigger first, then prioritise execution. A stop is therefore not a guaranteed maximum loss. Stop-limit orders add price protection after the trigger but introduce the risk of not being filled at all. (SEC)

How would you decide on an entry level?

I’d start with my estimate of fair value and what the market currently prices, then ask whether the expected upside from my thesis is attractive relative to the downside. I’d consider volatility, liquidity, recent price action, important market levels and upcoming catalysts, but I would not use technical levels mechanically. If the opportunity remained attractive but timing was uncertain, I might scale into the position rather than commit all the risk at one level. Most importantly, I would avoid chasing a market after the price has already moved far enough that the original risk–reward has disappeared. CONTEXT / INTUITION: A good view can become a bad trade at the wrong price. Entry level matters because it changes both how much upside remains and how far the market can move against you before your thesis is genuinely wrong.

How would you set a stop-loss?

I’d first define what market level or development would invalidate or materially weaken my thesis rather than choosing an arbitrary percentage loss. That could be a fundamental change, a key relative-price relationship breaking down or a price move inconsistent with the mechanism I expected. I’d then make sure the stop allows for normal market volatility and use the distance from entry to that invalidation point to help size the trade. I would also distinguish between a risk-management level and an actual stop order, because in some markets I might reduce or reassess manually rather than rely on a mechanical stop. CONTEXT / INTUITION: The principle is to decide what would make you wrong before the trade becomes emotional. But a stop should sit where the thesis is challenged, not merely where the P&L becomes uncomfortable. And because stop-market orders can gap through their trigger, they are not complete protection against tail risk.

How would you size a position?

I’d start with the amount of loss I’m willing to tolerate if the thesis is wrong, then work backwards from the entry price, invalidation or stop level and the instrument’s volatility to determine the appropriate size. I’d also adjust for liquidity, event risk and how uncertain the thesis is. Crucially, I’d look at portfolio-level exposure rather than sizing every position independently, because several different trades may all express the same underlying factor or macro view. CONTEXT / INTUITION: Suppose you’re long Treasuries, long rate-sensitive equities and short the dollar because you expect aggressive Fed easing. They look like three different positions, but one hawkish surprise could hurt all three simultaneously. Good sizing therefore means thinking in terms of common risk factors and correlated losses, not just individual trade labels.

How do risk–reward, probability of success and expected value relate to one another?

Risk–reward compares the size of the potential gain with the size of the potential loss, but it says nothing about how likely either outcome is. Expected value combines both: roughly, probability of winning × average gain minus probability of losing × average loss. For example, if I gain £200 when right, lose £100 when wrong and succeed 40% of the time, the expected value is £20 per trade before transaction costs. This means a strategy can be profitable with a low win rate if its winners are sufficiently large, while a high win rate can still lose money if occasional losses are severe. CONTEXT / INTUITION: The maths is easy; the difficult part is estimating probabilities honestly. In markets those probabilities are uncertain, change over time and are often impossible to know precisely, so expected value should be a framework for disciplined thinking rather than a falsely precise calculation.

How would you manage event risk and the possibility of the market gapping through your stop?

I’d identify events that can create discontinuous price moves — such as central-bank decisions, inflation releases, elections, earnings or geopolitical developments — and assess how my position behaves across plausible scenarios rather than relying only on recent volatility. Ahead of the event, I could reduce the position, hedge part of the exposure, close it temporarily or use options to define downside if that fits the thesis. I’d assume that a stop-market order may execute well beyond its trigger if the market gaps, so the position should be sized so that a worse-than-expected exit is survivable. CONTEXT / INTUITION: If an asset closes at 100, your stop is 95 and unexpected news makes the next tradable price 85, the stop cannot magically sell you at 95. Event risk is therefore about the whole distribution of possible jumps, not merely the distance from today’s price to your stop. This is why stress testing and sizing matter more than blindly relying on stop-loss orders. (SEC)