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Concerning risk per trade sizing
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Concerning risk per trade sizing

  #101 (permalink)
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Deucalion View Post
Magnificent point. Context is everything. There is even a point of view that every trade one takes...no matter what kind of trade, or context or strategy or entry exit point or risk tolerance.........has a probablity of 50/50. This is arguable...highly arguable. That means there is no diffrence between a monkey and a risk cognizant trader....and while that makes good copy here I doubt it would stand up to scrutiny.

I have seen enough good discretionary traders that make Mike's point so potently valid and the 50/50 probability point invalid (with context). Understanding when to apply what, how to trade a range day versus a trend day vs a reversal day, context of news, of truly contrarian thought, of levering up when things literally fall into your lap and mostly to simply not commit any money to the market at other times is a life long learning process.....

I think there is a definite distinction in my view. The possible outcomes of a single trade is binary, namely win or lose, therefore 50/50. That does not mean the probability of that trade being a winner is 50/50. Probability is based on observed history and cannot be defined without historical sample, so if you have observed that specific trade winning 800 out of the last 1000 occurrences, the next time that trade shows up, it's possible outcomes are still 50/50, but it's probability of winning based on historical evidence is 80%.

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  #102 (permalink)
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Big Mike View Post
Hmm, not sure I can really agree on this.

You are both driving on the same Interstate highway, but one of you is driving a Pinto, and the other a 18-wheeler weighing 40 tons. You might be on the same road with the same exits or red lights, but the playing field is hardly level. For proof, simply drive your Pinto straight into the 18-wheeler and see if he even notices or if he just thinks a bug hit the windshield.

Mike

I was 8 years old when I saw this in real life. It was a gruesome sight and it brought back a real life story. Sorry for the reality sad break..

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  #103 (permalink)
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Deucalion View Post
There is even a point of view that every trade one takes...no matter what kind of trade, or context or strategy or entry exit point or risk tolerance.........has a probablity of 50/50. This is arguable...highly arguable.

This is more than highly arguable, it's downright false. The chance of the market moving in the direction of the trade is, in fact 50/50 - as the market can only go with or against the trade (assuming that staying still is not counted as an option - which it is sometimes).

But that is not what a real trade is. A trade is a bet on a set of parameters, each of which has its own varying probability.

So the true chances of a real trade being successful are significantly smaller than 50/50 if you account for the actual parameters necessary for a real-world trade.

If we could try to define it, we would have to say, at minimum, something like: "a trade is a bet that the market will go a certain direction, from a certain point, without going backwards beyond a certain amount, and go far enough in the right direction to be close-able for a reward."

By comparison, when stocks are chosen at random, then compared to fund managers' performance, there is generally only one parameter (performance v. the S&P).

When they created the "Monkeydex" (where a monkey picked some stocks & they outperformed the S&P), all the monkey had to do was pick some names - it didn't even have to pick a direction (long or short). Thus, the number of parameters was extremely limited, and the chances of success were automatically much higher. The monkey didn't have to set a risk-level it could not afford to go beyond, decide where to close the trade/leave it open, or anything else. Some of the monkey's picks could have lost 90%, then come back at the end of the year, and been counted as winners in the final totals - because risk-limitation was not a parameter.

So what is the actual probability of success for any given trade?

Virtually impossible to calculate, but that doesn't prevent us from making a basic rough-out of what the average probability might look like:

Let's assume, for the sake of simplicity, that all variables have 50% probability (which, of course, they don't).

What are the necessary variables? (as in cannot be eliminated for real-world trading).
Well, what are the things you're betting on?

1. Trade direction.

2. That it will go that direction without retracing back past a certain amount (your stop).

3. That not only will it go your direction, but go far enough to cause you to close it (reach some kind of satisfactory target). The trade can go your direction one tick, and you have satisfied variable #1 - but that does not make a successful trade - you are betting that it will go a certain minimum distance - or you wouldn't have taken the trade. This is significantly different from just looking back at the Monkeydex at the end of the year, & saying "yep, stocks are up."

So a rough-&-dirty calculation might look like this:

Probability #1 (direction): 50%
Probability #2 (stop): 50%
Probability #3 (distance): 50%

So that gives us, best-case scenario odds (based on random chance alone) of 12.5% (50% x 50% x 50%).

Of course, the probability of success could be significantly less than 50% for variables #2&3 - depending on how you handle them (too tight stops, unrealistic targets, etc.). And your chances of getting the direction right could, of course, be much better or worse than 50%.

But you get my point, right? If a trader is batting .500, in all reality, that's measurably better than just raw chance alone - if you account for all the necessary parameters of an actual trade.


Last edited by ddouglas; March 7th, 2012 at 09:25 PM.
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  #104 (permalink)
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So a rough-&-dirty calculation might look like this:

Probability #1 (direction): 50%
Probability #2 (stop): 50%
Probability #3 (distance): 50%

So that gives us, best-case scenario odds (based on random chance alone) of 12.5% (50% x 50% x 50%).


---

Let's pretend we trade the ES and open one trade a day at the open. Direction is selected randomly, stop loss= 2 pts, profit target = 2 pts. What are the odds to win or lose ? 12.5% or 50%

me think it is 50%

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  #105 (permalink)
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trendisyourfriend View Post
me think it is 50%

I don't want to rain on your party, but you understand what I mean, right? I hear "50%" all the time from all kind of different sources.

Truth is, the minute you add a qualifier to that 50%, it is no longer 50%.

If you open a bet at random on the open every morning in the S&P, & bet "long" or "short," you DO have a 50% chance of winning.

Will you hold it if it goes 50 points against you? What if it goes 50pts against you, then reverses and becomes a 20pt win? (stranger things have happened). That still counts as a win for probability purposes - and if you said "long, but no more than 45pts against me," you would have turned it into a loss.

Is an example this extreme totally useless? Of course not, everything else is just a smaller degree. I'm just exaggerating to illustrate a point. But if you chose "no further than 4.5 points against me" you are still potentially turning some winners into losers, and therefore reducing your chances below 50% - because some winners will retrace further than that before becoming winners.

50% chances on the direction of the market are only 50% if they are completely unqualified, and not limited by other parameters. Everything else is some degree smaller. (or a large degree smaller - depending on what it is).

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  #106 (permalink)
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Fair enough DD....what you have stated is a purely objective, empirical and mathematical point of view. Absolutely correct. And it subscribes to the random walk theory.

I doubt that view, markets are not random - what about huamn nature and discretionary ability. I do not take random trades, discretionary traders can't afford to. Purely objective traders HAVE to. As do systems. You point is correct for systematic trading.

When you buy weakness in strong market, the probability of that being a good trade is not the same as that of buying weakness in a weak market. And the other way around. These formulas have a place, the big picture context is everything to me. In the evolution of a trader, a newbie must treat every trade as if it will fail. An experienced trader will not.

Intuition, experience, information, risk tolerance, ability, tools....must skew this factor of chance....Trades taken with the structure of the market will do so too....key point is every trade cannot be viewed as such.....a machine acting on simple inputs is still influenced by the designers abilities and beliefs. If one believes that markets are an extension of human nature (and base one's trading on it)...you must re-examine the purely objective view that price action is truly random. I do not base my trading on random walk.

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  #107 (permalink)
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Big Mike View Post
@Private Banker, couldn't have said it better myself.

I know there are always the guys that say all in, all out is mathematically superior, and if that is what drives them to be good traders then hats off. For me I am more keen to play to my psyche and taking off risk along the way in a trade, scaling out, taking profits, it all works better for me.

I also scale in. For the longest time, I was afraid to do this because I misunderstood the message that is hammered home "do not add to losers". I started by only adding to trades when they had moved in my direction. But now I add to trades that both move in my direction, as well as move against me. However, there is an incredibly important distinction that you must make ---- has the trade moved against you, but is still valid? Or has the trade moved against you, and not your original trade idea is no longer a good one.

Clearly you shouldn't add in the second scenario when the trade is no longer a good trade. And that is where most people go wrong, they average down/dollar cost average to try to minimize pain. For me, I simply know ahead of time that I will likely add once, twice, maybe even three times in a trade, so I never put the full trade on in one spot.

But I also trade much bigger charts than I used to, and bigger charts than a lot of people on the forum these days. That is important because my stops are much bigger, as are my targets. Again, not talking about $$$. I am talking about distance in ticks, not dollars in ticks. I sometimes trade using my spot forex account and sometimes full sized futures, all depending on what the total trades I have working in the market are doing and how much my risk exposure is.

Mike

yes, completely agree, all in all out is mathematically superior.

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  #108 (permalink)
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Deucalion View Post
Fair enough DD....what you have stated is a purely objective, empirical and mathematical point of view. Absolutely correct. And it subscribes to the random walk theory..

I didn't say anything about random walk - nor do I subscribe to it.

I said that the idea of 50% probability is wildly flawed, and does not account for the other parameters that are imposed on real-world trading.

If you have an intelligent market bias, you can have a MUCH higher chance of getting market direction right. This has been proven over & over. But it is only one of the parameters that you need in order to be successful. You can still lose on the other two variables.

William Eckhart advised to try to not have more than three or four parameters to your system - because he believes that it makes your probability of succeeding too low.

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  #109 (permalink)
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Are you trying to suggest about trade execution probability without market context? I cannot even conceive of such a thing...I am not trying to be pedantic or an ass about it....but how does one reduce risk? The tools to reducing risk and making good decisions in anything increase the chance of a successful action...this would be true in anything. The probability of driving without ending in the ditch on ice for a driver with advance training is better than that of a noob....This, to me is very black and white...why does it not apply in trading? What am I missing here?

If price action is not random, then a trade taken in context with that view must have a greater chance of succeding than one without. Simply put.......

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Yes I know, I am being far too simplistic...but you understand the point I am trying to make....with discretion, tools, knowledge etc etc....you can skew that in your favour (not all the time but enough combined with positive expectancy). That is all. Lack of random Walk must be taken into account when taking a trade....I view it as integral to my trading plan and to my trades.

Yes, I understand that even with that intelligent bias, the probablity being 50% or 40% or 12.5% is a debatable point. And that was your point - the percent number. I agree, I have no clue on the actual percent number, I would much rather pay attention to bias and structure, trying to increase the chance and the gain from each successful chance (especially the 2nd point)...which is to lever up on what I call very high probablity trades. The last point is new to me over the past few months...but its net effect is crucial on the bottom line.


Last edited by Deucalion; March 7th, 2012 at 10:39 PM.
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  #110 (permalink)
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ddouglas View Post
I don't want to rain on your party, but you understand what I mean, right? I hear "50%" all the time from all kind of different sources.

Truth is, the minute you add a qualifier to that 50%, it is no longer 50%.

If you open a bet at random on the open every morning in the S&P, & bet "long" or "short," you DO have a 50% chance of winning.

Will you hold it if it goes 50 points against you? What if it goes 50pts against you, then reverses and becomes a 20pt win? (stranger things have happened). That still counts as a win for probability purposes - and if you said "long, but no more than 45pts against me," you would have turned it into a loss.

Is an example this extreme totally useless? Of course not, everything else is just a smaller degree. I'm just exaggerating to illustrate a point. But if you chose "no further than 4.5 points against me" you are still potentially turning some winners into losers, and therefore reducing your chances below 50% - because some winners will retrace further than that before becoming winners.

50% chances on the direction of the market are only 50% if they are completely unqualified, and not limited by other parameters. Everything else is some degree smaller. (or a large degree smaller - depending on what it is).

Apples and Oranges. I love it when discretionary traders debate probability. The very fact that your enter, manage, and exit any trade with any discretion, makes it impossible for you to determine probability of anything. Why? because every discretionary decision introduces a different variable that may or may not have been represented in the historical sample, therefore negates the entire sample. You based your historical sampling on apples, and oranges, and in real life, you are trading apples on one trade, oranges the next, and apricots the following trade.

Unless you are mechanical trader, the only way you can legitimately rely on probability is if you record and analyze a large sample of your actual trades, and calculate the data based on the sample of actual trades. Even then, you will not be measuring the technical probability of a certain type of trade, you will be measuring how effectively you manage those trades when you took them overall. The next time you take one of these trades, the outcome will be less affected by the winning probability of that type of trade, but more by which discretionary variable(s) you introduce in the execution and management of that singular trade, and the same holds true for each trade you take after that.

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