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Concerning risk per trade sizing


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Concerning risk per trade sizing

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  #101 (permalink)
 monpere 
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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)
 bluemele 
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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)
ddouglas
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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.

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  #104 (permalink)
 trendisyourfriend 
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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)
ddouglas
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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)
 Deucalion 
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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)
 Silvester17 
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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)
ddouglas
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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)
 Deucalion 
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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.......




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.

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  #110 (permalink)
 monpere 
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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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  #111 (permalink)
 Deucalion 
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monpere View Post
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.

That is what I should have said in the first place...

I do not know what else to technically call it......higher chance, better trade sequence...whatever....I take 10 sequences into account, throw the 9 comfortable ones away, and take the one that scares me the most . Yes, yes...that's not exactly how it goes...it's freaking 10PM EST and I am still here...time for bed....

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  #112 (permalink)
ddouglas
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Deucalion View Post
trade . . probability without market context?

Yes, exactly.


Deucalion View Post
I cannot even conceive of such a thing...

Then you cannot fairly discuss probability - because probability without market context is the only way to compare trading performance against pure "random chance alone."

This is why people are continually bringing up things like coin-toss probabilities when talking about trading, because it provides a context to talk about probability without opening a can of worms involving market context.

Many people believe that "random chance alone" for any given trade to succeed is somehow 50% - and that if your win-rate is less than that, then you are somehow doing worse than if you just bought-and-held, or threw darts, or some other silly non-strategy.

All I'm saying is that the actual "random chance alone" for any real-world trade to succeed is MUCH, MUCH lower than 50%.

If you flip a coin and go Long-on-Heads, Short-on-Tails, that is one parameter. Which has a 50% chance of success.
If you say "Long-on-heads, with a 10-pt stop", that is two parameters - with MUCH less chance of success than the one-parameter example.

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  #113 (permalink)
ddouglas
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monpere View Post
The very fact that your enter, manage, and exit any trade with any discretion, makes it impossible for you to determine probability of anything.

Does this mean you have no probability of winning? Or a un-determinable probability of winning? In all reality, neither one of these things is true. Not only do you still have a probability of winning/losing, but it can be calculated within a reasonably accurate range.

A mechanical trader does have the advantage that their calculable ranges are probably tighter than a discretionary trader's, but that is all.

And in some cases, this could be a liability, rather than an asset.

"An approximate answer to the right problem is worth a good deal more than an exact answer to an approximate problem. " - John Tukey

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  #114 (permalink)
 Deucalion 
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Ok, I am still up...this is something I haven't thought about since school.....so I am thinking about it now.....Yes...correct.. technically speaking I am unfairly using the words with the concept... technically speaking.


I think we are getting carried away by definitions…….Probability as it pertains to pure random chance versus chance as it pertains to discretionary trading…..(if we were all systematic mechanical traders this entire forum at futures.io (formerly BMT) would be the realm of mathematicians, statisticians and programmers and no one else)

If we take pure random trading….using independent normally distributed functions, each such added function would result in the exponential joint probability curve…defined as multivariate distribution

Each parameter (in itself normally distributed) at 50%, two would make it 25%, then 12.5%, then 6.25%...and so on……roughly speaking P(x1,x2,x3…) = P(x1) * P(x2)*P(x3)…..and so on…assuming normal distribution for each parameter…we could define this as you already stated….such as this…(the actual formula is much more dry….. here….but it essentially boils to the above and the plot below)



Yes, technically how can one argue against that? This is not important in discretionary trading at all…for one thing…we are now talking about normalized Gaussian distribution instead of multivariate joint exponential probability….so the curve immediately looks like this…..



On the other hand, when I take a short in an uptrend, I call that a low probability trade (maybe I should call it something else, like a low chance trade). When I take a short in a downtrend I would call that a higher probability (chance) trade……I think we are getting hung up on definitions……that wasn’t my point.

Call it whatever you want to call it, the point was that if one takes higher chance trades risk is automatically reduced of damage to account….identifying such higher chance trades is a different thing all together……Fair description or not, this is like missing the forest for the trees….this thread is about risk in trading, about mitigating and managing it. One prime way to do that is taking contextual trades, and increasing one’s read on the market to lower the risk of loss, not just by stops but more by not trading, trading smaller, scaling in…….passing on trades…etc etc…
So tomorrow morning, when I set up my sequences, I will still call them low or high probability trades based on my read…..whether that is technically correct or not…is probably not as important as getting my context correct.

It might be more interesting to discuss whether the markets are Gaussian or not, and how often do fat tail events squeeze the distribution, and how algos are changing the distribution curve..Although that’s way past me…




Edit - notice that i do not want to focus on chance percent of a sample of trades but the nature of the market itself and trades based on that.... because that to me is more relevant than a gaggle of normally distributed trades. So I am digressing from your response, and its on purpose.

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  #115 (permalink)
ddouglas
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Deucalion View Post
I think we are getting carried away by definitions……

Each parameter (in itself normally distributed) at 50%, two would make it 25%, then 12.5%, then 6.25%...and so on…

Yes, excellent! That's all I was trying to say in the first place.

Then, it's the trader's job to try to make each parameter have the highest probability of winning - ie, taking with-trend trades, like you spoke of, etc. Dialing your stops up/down for greatest chances of success, & so on.

But I keep hearing this "50% chance of winning" idea, and wanted to point out that it's not correct ..

Now that it's been put to bed by your post, I think we're on the same page.



Thanks.
-Doug

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  #116 (permalink)
 Massive l 
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monpere View Post
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.

Do you believe a baseball player with 5 years of hitting stats has an inaccurate data set for probabilities just because he picks and chooses his pitches to hit?

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 Deucalion 
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ddouglas View Post
Yes, excellent! That's all I was trying to say in the first place.

Then, it's the trader's job to try to make each parameter have the highest probability of winning - ie, taking with-trend trades, like you spoke of, etc. Dialing your stops up/down for greatest chances of success, & so on.

But I keep hearing this "50% chance of winning" idea, and wanted to point out that it's not correct ..

Now that it's been put to bed by your post, I think we're on the same page.



Thanks.
-Doug

Even though I am a big picture guy all the time, the devil is in the details. Many time I have ignored the small bits and they have come back to bite me...so thank you for making me think..things like this encourage me to come back to futures.io (formerly BMT)

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  #118 (permalink)
 Big Mike 
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trendisyourfriend View Post
Mike, could you give an example of such a trade where price has moved against you while still considering your original premise valid? I'd be interested to see such a trade on your bigger chart interval that you currently use.

If i consider my own experience specially on the ES where price can go up and down the same distance during the day session i must admit i would not know how to deal with that effectively psychologically speaking. What rules of thumb or recommendation can you share to help in that department.

Also, how can you effectively manage such a trade if you trade during regular hours ? I typically trade the regular session from 8:30 AM to 4:00 PM EST. I don't trade during the night. I am trying to determine if i can increase my interval but not at the expense of my life.

Let's say I enter a trade here. My stop is 50 ticks away, and my first target is also 50 ticks away. I enter here because it is moving higher, and just bounced off a support level.

Maybe after I enter, price moves down some but not all the way down to my 50 tick stop, which was placed there because that is beyond the next support shelf level, and I concede that if price moves to this area, I was wrong about this trade. So it has moved down some -- lets say 20 ticks -- but then it stops and starts moving higher again.

This happens often, as it breaks through just enough of the prior support level to trap some shorts or to take out prior longs.

In this case, my trade is still valid because I had planned for this as a possible event. It is not enough to simply say this happens all the time, so wait for price to move down 20 ticks before entering in the first place. Sometimes that works, sometimes it does not. I prefer to take my position when I see my setup, and add to my position when I feel that the above scenario has happened, or the other scenario is when price makes a HH+HL combo in this case.

As for RTH session times, I am not following how that has any bearing. Sometimes I do hold trades overnight, but not most of the time.

Mike

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  #119 (permalink)
 Big Mike 
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monpere View Post
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.

Strongly disagree.

Mechanical traders and automated traders base their probabilities on prior backtests or prior forward tests. Either way, it is on a set of sample trade data.

Discretionary traders do the same thing. As I explained before when you brought this up, if you take the prior 1,000 discretionary cash trades and analyze them, you can define threshold parameters for what the next few hundred trades may look like --- just like you would with a mechanical or automated system.

It is all apples. Not apples and oranges. Apples for my last 1,000 trades, and apples for my next 1,000. All apples and all consistent with the same approach.

Mike

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 Big Mike 
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monpere View Post
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.

Bob drives to work every day for the last 10 years using the exact same route from his home to his work place. He also drives home every day the exact same route from his work place to his house.

He drives himself. He does not have a robot driving for him and he is not using cruise control, GPS, or some other mechanical system. He is a discretionary driver. If he wants to change lanes, he does so, he does not need to wait for his rule book to say it is ok to change lanes.

Over the last 10 years, Bob has found it takes him between 30 and 40 minutes to get to work.

How long do you think it will take Bob to get to work for the next few months, on average?
A) 30-40 minutes
B) 5 minutes
C) 2 hours

Mike

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  #121 (permalink)
 monpere 
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Big Mike View Post
Bob drives to work every day for the last 10 years using the exact same route from his home to his work place. He also drives home every day the exact same route from his work place to his house.

He drives himself. He does not have a robot driving for him and he is not using cruise control, GPS, or some other mechanical system. He is a discretionary driver. If he wants to change lanes, he does so, he does not need to wait for his rule book to say it is ok to change lanes.

Over the last 10 years, Bob has found it takes him between 30 and 40 minutes to get to work.

How long do you think it will take Bob to get to work for the next few months, on average?
A) 30-40 minutes
B) 5 minutes
C) 2 hours

Mike

If I put 3 apples in a jar today, and tomorrow I remove 1, how many oranges do I have left in the jar? Analogies only ridicule complex topics. You want to illustrate, use actual trading examples.

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 Deucalion 
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Hang on, he is right about that. A lot of times I will close my trade before it reaches target and before it stops me out, often I scratch a trade, based on new unfolding information (I expect deviations on a trade ALL the time......Sometimes I will add to a trade when I did not expect to, or like today on CL expand on final target. I do not expect deviations in driving that often), upcoming news, change of pace, size and depth of corrective wave and/or something else. i have not yet come up with a way to quantify all those factors. So how can i determine probability.

Driving a car on the same road.....has a very set defined rules and reactions to deviations. There are no fat tail events.....the road won't open up and swallow Bob..LOL



There can only be a small rudimentary set of deviations...accidents, delays, reroutes...all easily identified. Perhaps the same can be done with price action and what factors affect a trade...but it wouldn't be as clear cut and simple....

I can replay a market but I can't backtest or forward test them, I am in that apples to oranges camp. Not saying it can't be done, just that....I can't even begin to quantify them...I mean..for one thing...even a basic thing as a pattern recognition....I can't quantify that...And if the the same pattern were to re-appear at an odd time of day, or under some other factor I could either take it or ignore it.

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 Massive l 
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Regardless of whether it's discretionary or automated, every trader has stats that give insight into what might happen on the next set of trades. I have an expectancy, e-ratio, r:r, winning percentage, etc. Just because I pick and choose the trades, doesn't mean I'm throwing darts at a wall.

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 monpere 
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Big Mike View Post
Strongly disagree.

Mechanical traders and automated traders base their probabilities on prior backtests or prior forward tests. Either way, it is on a set of sample trade data.

Discretionary traders do the same thing. As I explained before when you brought this up, if you take the prior 1,000 discretionary cash trades and analyze them, you can define threshold parameters for what the next few hundred trades may look like --- just like you would with a mechanical or automated system.

It is all apples. Not apples and oranges. Apples for my last 1,000 trades, and apples for my next 1,000. All apples and all consistent with the same approach.

Mike

...

monpere View Post
...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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 worldwary 
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Markets have a way of thwarting expectations. It is important to remember that no one, whether the mechanical trader or the discretionary trader, can know that there is an 80% chance (or whatever percentage) that the next trade will be a winner. Market conditions change and evolve. Our probability analysis is based on prior trades/market conditions, not future or even present conditions.

Changing conditions are difficult to measure in real time Gbut it's critical to recognize that the ground can shift. Imagine if the laws of physics were subject to change without warning, and what impact that would have on probability analysis of an outcome in the physical world. That is the world that traders work in.

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 ddnut 
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Big Mike View Post
Let's say I enter a trade here. My stop is 50 ticks away, and my first target is also 50 ticks away. I enter here because it is moving higher, and just bounced off a support level.

Maybe after I enter, price moves down some but not all the way down to my 50 tick stop, which was placed there because that is beyond the next support shelf level, and I concede that if price moves to this area, I was wrong about this trade. So it has moved down some -- lets say 20 ticks -- but then it stops and starts moving higher again.

This happens often, as it breaks through just enough of the prior support level to trap some shorts or to take out prior longs.

In this case, my trade is still valid because I had planned for this as a possible event. It is not enough to simply say this happens all the time, so wait for price to move down 20 ticks before entering in the first place. Sometimes that works, sometimes it does not. I prefer to take my position when I see my setup, and add to my position when I feel that the above scenario has happened, or the other scenario is when price makes a HH+HL combo in this case.

As for RTH session times, I am not following how that has any bearing. Sometimes I do hold trades overnight, but not most of the time.

Mike

Doesn't this illustrate the apples vs. oranges argument in a way? You entered the trade with a fixed target and stop and an expected success rate based on prior experience. Then based on how the trade progressed you added a contract. This could also be considered to be a separate, independent trade. In any case, the expected sucess rate going in has changed, no?

The point is that each discretionary decision changes the end results. Hopefully for the better or otherwise you would not be a discretionary trader.

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 trendisyourfriend 
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There are many departments where subjectivity along with common sense prove to be superior to mechanical processes.

For example, when does a change of trend occur?

No matter how complex your rules might be to define when a change of trend has occured, you will always have cases that does not fit your set of rules. Common sense along with subjectivity is more apt to deal with unexpected exceptions when they occur.

Another example, you believe that S/R are emotional meeting points where traders like to make business and take important financial decisions. No matter the reasons why you like S/R. You use them to define the overall structure within which price moves.

But this poses an interesting problem, how do you define these key levels? swing lows and highs ? but what about these times when price behaves a bit erratically and produces many swing highs/lows making your structure looks like a pick-up sticks game .

Don't you think, common sense and subjectivity would be better to identify the important swing highs/lows by loosening the rules just enough to find the most likely tradable structure? I tried your indicator in the download section that identifies levels of S/R and to be honest it is not up to snuff when it comes time to identify a workable market structure.

Another area where discretion is even more necessary and superior is when you see patterns on the chart which create an obvious expectation within the retail traders. When future price movement fails to meet expectations and you see traders becoming trapped in the wrong direction. These situations offer a high probability setup to the astute trader but in my mind these scenarios can only be dealt effectively with discretion and your common sense. Trying to profit from these losing traders would be a Herculean task (titanesque task) with rigid rules.

Hope it provided a few ideas to your illustration need


monpere View Post
If I put 3 apples in a jar today, and tomorrow I remove 1, how many oranges do I have left in the jar? Analogies only ridicule complex topics. You want to illustrate, use actual trading examples.


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 liquidcci 
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There are so many counteracting forces in the market I have never considered I was competing with anyone. So many people in market large and small doing different things at different points in time for different reasons it is hard for me to see anyone large or small as my competition. However, within that chaos trends can be identified which is why we can measure probabilities and make money.

Someone may be going short the moment I enter a long trade but we both could profit depending on our stops, targets time frames etc.. I don't consider whoever was on the opposite side of my trade as competition. We may both come out on top.

I think if I am competing against anyone it is against myself. To beat the market is to be able to consistently identify the direction of the river and win the battle against my own bad tendencies.

"The day I became a winning trader was the day it became boring. Daily losses no longer bother me and daily wins no longer excited me. Took years of pain and busting a few accounts before finally got my mind right. I survived the darkness within and now just chillax and let my black box do the work."
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 monpere 
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trendisyourfriend View Post
There are many departments where subjectivity along with common sense prove to be superior to mechanical processes.

For example, when does a change of trend occur?

No matter how complex your rules might be to define when a change of trend has occured, you will always have cases that does not fit your set of rules. Common sense along with subjectivity is more apt to deal with unexpected exceptions when they occur.

Another example, you believe that S/R are emotional meeting points where traders like to make business and take important financial decisions. No matter the reasons why you like S/R. You use them to define the overall structure within which price moves.

But this poses an interesting problem, how do you define these key levels? swing lows and highs ? but what about these times when price behaves a bit erratically and produces many swing highs/lows making your structure looks like a pick-up sticks game .

Don't you think, common sense and subjectivity would be better to identify the important swing highs/lows by loosening the rules just enough to find the most likely tradable structure? I tried your indicator in the download section that identifies levels of S/R and to be honest it is not up to snuff when it comes time to identify a workable market structure.

Another area where discretion is even more necessary and superior is when you see patterns on the chart which create an obvious expectation within the retail traders. When future price movement fails to meet expectations and you see traders becoming trapped in the wrong direction. These situations offer a high probability setup to the astute trader but in my mind these scenarios can only be dealt effectively with discretion and your common sense. Trying to profit from these losing traders would be a Herculean task (titanesque task) with rigid rules.

Hope it provided a few ideas to your illustration need

1. No one is debating the superiority of any methodology. I never said one methodology is superior to another. I believe anyone can make money using any methodology, as long as they understand it and apply it well.

2. I accept your criticism of my S/R indicator. Like with any indicator, some have found it helpful, some not . Although I am not sure how that is relevant to this conversation. So no further comment there.

3. I don't know how one 'sees' trapped traders, I'm not part of the borg collective, so I don't know who is trapped and who is not. Since you mention it, I guess you have a window onto every trader's entries, stops and exits which determines their level of entrapment.

4. If this is the first time the market produces the pattern of pick-up sticks, then yes, it may well be that my entries will get trounced, maybe, maybe not, that depends on my exact methodology, so no conclusion can be made in that regard.

5. If the market regularly produces pick up sticks patterns, then it will be reflected in my backtesting data, therefore will be reflected in my probability data. Furthermore, if my method was not designed for pickup sticks market environments, then I will not be trading that market action. If my method cannot tell the difference, then I have crap method, and no amount of probability calculation will help me.

The question here is when one says this is a high probability trade, what does that mean? Is it something you can base your trading methodology on, or is it something that makes you feel better about taking the next trade? You say a 'Trapped traders' setup is High probability, How high is high? I can say my 'CL 4Range Double Divergence' setup is 80% win probability, because I trade it the exact same way that it was defined in the 1000 occurrences of it in my backtest. So 80% is a defined and reasonable expectation. How do you define 'High' in that trapped traders setup? 80%, 65%, 110%, or is 'High' determined by how you enter, manage, and exit, this particular single occurrence based on discretion, and your physical and mental state at that time? In which case 'High' this time around, means a different thing then 'High' the next time around.

PS: Please don't answer with analogies of baseball players, pintos and 18 wheelers.

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 liquidcci 
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In regard to market being random. I think at any given moment their can be randomness about it. But overall it is not random. At one time I was convinced it was random until I started really using probabilities in my trading. My probabilities clearly say it is not random.

"The day I became a winning trader was the day it became boring. Daily losses no longer bother me and daily wins no longer excited me. Took years of pain and busting a few accounts before finally got my mind right. I survived the darkness within and now just chillax and let my black box do the work."
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 Surly 
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liquidcci View Post
In regard to market being random. I think at any given moment their can be randomness about it. But overall it is not random. At one time I was convinced it was random until I started really using probabilities in my trading. My probabilities clearly say it is not random.

I agree. In response to theorists who profess the doctrine of random walk I quote Samuel Johnson...

"After we came out of the church, we stood talking for some time together of Bishop Berkeley's ingenious sophistry to prove the non-existence of matter, and that every thing in the universe is merely ideal. I observed, that though we are satisfied his doctrine is not true, it is impossible to refute it. I never shall forget the alacrity with which Johnson answered, striking his foot with mighty force against a large stone, till he rebounded from it, 'I refute it thus.'"

Seek freedom and become captive of your desires. Seek discipline and find your liberty. - Frank Herbert
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 trendisyourfriend 
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monpere View Post
...

3. I don't know how one 'sees' trapped traders, I'm not part of the borg collective, so I don't know who is trapped and who is not. Since you mention it, I guess you have a window onto every trader's entries, stops and exits which determines their level of entrapment.
...

Domage this concept is not discussed more often as i think it's at the heart of the trading game. Trapped traders is a concept that has to do with crowd psychology specially when stressful situations occur. You don't need to be a cyborg to predict how a large group of participants will react if stress enters into the equation. This is similar to what can be seen in a shopping mall when a smoke alarm sounds. You can almost predict with a high degree of certainty the crowd will move toward the many exits. Same concept is applicable to trading participants at S/R.

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r3algood
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All this debate is good and all but I think the thread needs to take a step back and refocus.

The only thing that matters in trading is whether YOU are consistently profitable, not your friend, or your buddy on the forums.

Trading is a probabilities game, who cares whether it is 0%-100% or anywhere in between?

You will either make money or lose money on a trade.

Again, the only thing that matters in trading is whether YOU are consistently profitable.

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r3algood
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Big Mike View Post
Bob drives to work every day for the last 10 years using the exact same route from his home to his work place. He also drives home every day the exact same route from his work place to his house.

He drives himself. He does not have a robot driving for him and he is not using cruise control, GPS, or some other mechanical system. He is a discretionary driver. If he wants to change lanes, he does so, he does not need to wait for his rule book to say it is ok to change lanes.

Over the last 10 years, Bob has found it takes him between 30 and 40 minutes to get to work.

How long do you think it will take Bob to get to work for the next few months, on average?
A) 30-40 minutes
B) 5 minutes
C) 2 hours

Mike

A) 30-40 Minutes.

Discretionary trading is almost exactly like your analogy here. Bob instinctively knows when to change lanes, he doesn't need to consult his drivers manual before doing so. He instinctively knows how to get to his workplace, he doesn't need to consult a map. The problem with beginners that attempt discretionary trading is that they simply do not know enough or practiced enough or had enough live trades to get this "instinctive rule book" in their heads. AND once people do have the "instinctive rule book" in their heads they sometimes find out that their rules aren't suited for making money in the markets and must change or go broke.

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r3algood
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Big Mike View Post
Strongly disagree.

Mechanical traders and automated traders base their probabilities on prior backtests or prior forward tests. Either way, it is on a set of sample trade data.

Discretionary traders do the same thing. As I explained before when you brought this up, if you take the prior 1,000 discretionary cash trades and analyze them, you can define threshold parameters for what the next few hundred trades may look like --- just like you would with a mechanical or automated system.

It is all apples. Not apples and oranges. Apples for my last 1,000 trades, and apples for my next 1,000. All apples and all consistent with the same approach.

Mike

Discretionary traders do the same thing. As I explained before when you brought this up, if you take the prior 1,000 discretionary cash trades and analyze them, you can define threshold parameters for what the next few hundred trades may look like --- just like you would with a mechanical or automated system.

It is all apples. Not apples and oranges. Apples for my last 1,000 trades, and apples for my next 1,000. All apples and all consistent with the same approach.


Best way of putting it in the entire thread.

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 monpere 
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Big Mike View Post
Strongly disagree.

Mechanical traders and automated traders base their probabilities on prior backtests or prior forward tests. Either way, it is on a set of sample trade data.

Discretionary traders do the same thing. As I explained before when you brought this up, if you take the prior 1,000 discretionary cash trades and analyze them, you can define threshold parameters for what the next few hundred trades may look like --- just like you would with a mechanical or automated system.

It is all apples. Not apples and oranges. Apples for my last 1,000 trades, and apples for my next 1,000. All apples and all consistent with the same approach.

Mike

Ok, I'll bite. And as always, I believe in putting some teeth behind the rhetoric. I trade a 4 range chart mechanically, so the method can easily and accurately be backtested, because every trade is identical. I can manually backtest 1000 trades in about 4 hours easily and gather the stats.

Big Mike, you now trade very big charts. The smallest chart you mention trading is 60m, and use S/R based stops and targets on even larger charts, and you scale in, and scale out at various discretionary points. That is what I gather from your most recent posts. Based on those parameters, I think we can agree that backtesting this methodology would be less then accurate, and that is the reason you mentioned forward testing actual trades.

Based on all the above, let's conservatively assume you are taking an average of 1 trade every 2 or 3 days. Let's also conservatively assume that there may several days sometimes when you are not in any trade at all. How many days will it take you to forward test 1000 actual cash trades? I know you trade live, but for the sake of this argument lets say, given you are trading 'probability', we'll assume you will not trade live until you get the numbers from the 1000 trades. How many days will it take you to forward test?

Not judging your style of trading, or methodology, or any nonsense like that. Just binging the rhetoric down to reality for the people who are reading these posts, trying to get real world ideas how to become profitable.

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 trendisyourfriend 
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monpere View Post
... How many days will it take you to forward test 1000 actual cash trades? I know you trade live, but for the sake of this argument lets say, given you are trading 'probability', we'll assume you will not trade live until you get the numbers from the 1000 trades. How many days will it take you to forward test?
...

Although it is adressed to Mike my answer to this is that a discretionary trader (the way i conceive it) does not feel the need to backtest in the same way as a mechanical trader would do. If you have a good understanding of what moves markets, what causes price to move and crowd psychology you would focus your attention on the process of trading not on triggers/signals or probabilities. You know the game is not about probabilities but about traders taking decisions and the impact it has on potential future order flow and future trend direction. The forward test is part of the process of trading, it is not an end in itself. A mechanical trader underestimates the value of skills in trading, he would look at markets as a big video game with red and green lights.

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 Big Mike 
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ddnut View Post
Doesn't this illustrate the apples vs. oranges argument in a way? You entered the trade with a fixed target and stop and an expected success rate based on prior experience. Then based on how the trade progressed you added a contract. This could also be considered to be a separate, independent trade. In any case, the expected sucess rate going in has changed, no?

The point is that each discretionary decision changes the end results. Hopefully for the better or otherwise you would not be a discretionary trader.

I view it as one trade. Just like all my previous trades, I did not enter "all in". I entered knowing full well that I would add at a later opportunity, should one arise --- and that I would not add later should the opportunity not arise.

I pick one direction and trade that direction the entire day. If you are trading long/short (switching directions) a lot during the day then my approach is not going to work for you, and if you can make such an approach work then almost certainly AIAO would be better in this situation than scaling. But I haven't traded that way in a long time, and I find my slower way to be far better (for me personally).

Mike

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  #139 (permalink)
 Big Mike 
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liquidcci View Post
There are so many counteracting forces in the market I have never considered I was competing with anyone.

I always think of trading as a competition against other traders. I think trading is every bit as much knowing what the other traders around you are doing as much as it is knowing what you want to do, and then of course recognizing when a bunch of traders are trapped -- and naturally, when you are (and to get out).

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  #140 (permalink)
 Big Mike 
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monpere View Post
Ok, I'll bite. And as always, I believe in putting some teeth behind the rhetoric. I trade a 4 range chart mechanically, so the method can easily and accurately be backtested, because every trade is identical. I can manually backtest 1000 trades in about 4 hours easily and gather the stats.

Big Mike, you now trade very big charts. The smallest chart you mention trading is 60m, and use S/R based stops and targets on even larger charts, and you scale in, and scale out at various discretionary points. That is what I gather from your most recent posts. Based on those parameters, I think we can agree that backtesting this methodology would be less then accurate, and that is the reason you mentioned forward testing actual trades.

Based on all the above, let's conservatively assume you are taking an average of 1 trade every 2 or 3 days. Let's also conservatively assume that there may several days sometimes when you are not in any trade at all. How many days will it take you to forward test 1000 actual cash trades? I know you trade live, but for the sake of this argument lets say, given you are trading 'probability', we'll assume you will not trade live until you get the numbers from the 1000 trades. How many days will it take you to forward test?

Not judging your style of trading, or methodology, or any nonsense like that. Just binging the rhetoric down to reality for the people who are reading these posts, trying to get real world ideas how to become profitable.

I am not interested in fighting you, since it is clear what you think of me and my approach based on the content of your posts when you refer to me.

If you want more info from me on forward testing, sim vs cash, analyzing sample set data, chart sizing, instrument selection, and etc read this thread:


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  #141 (permalink)
 liquidcci 
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Big Mike View Post
I always think of trading as a competition against other traders. I think trading is every bit as much knowing what the other traders around you are doing as much as it is knowing what you want to do, and then of course recognizing when a bunch of traders are trapped -- and naturally, when you are (and to get out).

Mike

But Mike can you really see what other traders are doing. Market can be seen moving but to me knowing what they are doing is something different.

Many moons ago I traded against the specialist on slow moving AMEX stocks. I would just try to beat the specialist and take the 1/16 spread as the rules said if specialist was at front of line he had to let me go first. To a degree I could see where the specialist was trading and make my moves accordingly.. Of course once equities went to decimals spread got to tight so would no longer work.

However, in the futures market while I think it brings many comfort thinking they know what the other guy is doing I just do not believe it can be seen. The market is to big and fast with to many jumping in and out short and long on many different time frames and time horizons with different targets and stops. Now I do believe overall trends can be seen as collectively the market is moved by many participants. But that is still in a larger context so to bring it down to I am beating these guys who went short win I went long today just cant be measured or seen in my opinion.

However, my real point apart from my diatribe above is to say on a trade where I go long for example and they go short against my trade. Has that person really just personally traded against me. It is obvious we have two different opinions about the direction of the market but the time frame, the target , the stop etc all are different. We both may profit , we both may lose, or one may win and the other profit. But we will get out at different times so we are not really trading against each other. Money is not transferred from my pocket to that persons if i lose or vice versa. In that context the market is not zero sum.

"The day I became a winning trader was the day it became boring. Daily losses no longer bother me and daily wins no longer excited me. Took years of pain and busting a few accounts before finally got my mind right. I survived the darkness within and now just chillax and let my black box do the work."
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  #142 (permalink)
 liquidcci 
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trendisyourfriend View Post
Although it is adressed to Mike my answer to this is that a discretionary trader (the way i conceive it) does not feel the need to backtest in the same way as a mechanical trader would do. If you have a good understanding of what moves markets, what causes price to move and crowd psychology you would focus your attention on the process of trading not on triggers/signals or probabilities. You know the game is not about probabilities but about traders taking decisions and the impact it has on potential future order flow and future trend direction. The forward test is part of the process of trading, it is not an end in itself. A mechanical trader underestimates the value of skills in trading, he would look at markets as a big video game with red and green lights.


trendisyourfriend View Post
he would look at markets as a big video game with red and green lights.


That is not a good characterization of a mechanical trader. Much of what you put in your post a mechanical trader simply puts into a system and leaves it alone with minor slow adjustments to system as stats warrant. Believe it or not my mechanical system takes into account "a good understanding of what moves markets, what causes price to move and crowd psychology " as you stated is more discretionary. Took many years develop but once I did why introduce discretion and why not use probabilities? Probabilities just make sense and open up so many possibilities and very consistent profitability. Discretion way to much influenced by emotion and vooddooo let me "feel what the market is telling me Luke"

Video game big green lights hardly.

"The day I became a winning trader was the day it became boring. Daily losses no longer bother me and daily wins no longer excited me. Took years of pain and busting a few accounts before finally got my mind right. I survived the darkness within and now just chillax and let my black box do the work."
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  #143 (permalink)
 monpere 
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trendisyourfriend View Post
Although it is adressed to Mike my answer to this is that a discretionary trader (the way i conceive it) does not feel the need to backtest in the same way as a mechanical trader would do. If you have a good understanding of what moves markets, what causes price to move and crowd psychology you would focus your attention on the process of trading not on triggers/signals or probabilities. You know the game is not about probabilities but about traders taking decisions and the impact it has on potential future order flow and future trend direction. The forward test is part of the process of trading, it is not an end in itself. A mechanical trader underestimates the value of skills in trading, he would look at markets as a big video game with red and green lights.

Ok, I'll bite again. Since we're talking about red/green lights, what exactly is wrong with that? Any red/green light system is as good as the method behind it. Good concept, good method, good system, crap concept, crap method crap system, that goes for mechanical, automated, discretionary, transcendental planetary alignment methods. The game is about probabilities for some and is about outsmarting thousands of other traders for others. What matters, is that what ever it is you do, is that you understand it, and you execute it well. But don't make the mistake of thinking you are doing something that your are not, because then you are just giving yourself a false sense of security.

As always, I am not just about the the atherial, vague, theoretical, mysterious, haiku, zen ponderings, or sports and traffic analogies applied to trading. So I will put teeth behind the rhetoric. In that spirit, here's a chart of my 'red/green light' system of the CL today. This time I am not putting my hand drawn arrows as I traded it. All the triangles and arrows on the chart are from the bare 'mechanical' indicator. The mechanical approach is, enter with a stop limit at the close of the bar with a triangle or arrow, 5 tick stop, 10 tick target, but I will give you the leeway to choose your target as you will. I trade with a break even algorithm, but I will not even include that in this example for simplicity. Now, Please examine every trade indicated by this 'mechanical' indicator on the included chart, and tell me what kind of day you would have had, if you traded this chart as is, mechanically, green light, red light, taking every signal.

I will save you all the math. At 2:1 risk/reward trading 1 single contract, 16 10tick winners, 10 5tick losers. I will add 1/2 a tick on each loser to average them out for slippage, and also add $5 commission for every trade, for a grand total of $920, in 4 hours just watching a red/green lights video game, trading a time frame that some of us would consider pure noise, and never risking more then $50 per trade.

Now, lets bring it back to the original intent of this thread. For the 1%-2% blanket risk followers, if I have a $20k account, which I would advise as a minimum to trade (lets even say a $10k just for kicks), What percentage of that account does $50 represent?


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 Adamus 
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liquidcci View Post
But Mike can you really see what other traders are doing. Market can be seen moving but to me knowing what they are doing is something different.

Many moons ago I traded against the specialist on slow moving AMEX stocks. I would just try to beat the specialist and take the 1/16 spread as the rules said if specialist was at front of line he had to let me go first. To a degree I could see where the specialist was trading and make my moves accordingly.. Of course once equities went to decimals spread got to tight so would no longer work.

However, in the futures market while I think it brings many comfort thinking they know what the other guy is doing I just do not believe it can be seen. The market is to big and fast with to many jumping in and out short and long on many different time frames and time horizons with different targets and stops. Now I do believe overall trends can be seen as collectively the market is moved by many participants. But that is still in a larger context so to bring it down to I am beating these guys who went short win I went long today just cant be measured or seen in my opinion.

However, my real point apart from my diatribe above is to say on a trade where I go long for example and they go short against my trade. Has that person really just personally traded against me. It is obvious we have two different opinions about the direction of the market but the time frame, the target , the stop etc all are different. We both may profit , we both may lose, or one may win and the other profit. But we will get out at different times so we are not really trading against each other. Money is not transferred from my pocket to that persons if i lose or vice versa. In that context the market is not zero sum.

I think you're precisely correct because the market is a double auction mechanism where changes in price are caused by changes in the speed and size of the order flow and in the electronic markets today there's no further detail. We can't prove any ideas about trapped traders or stop running etc, but they can still be very good ideas to explain the order flow.

So at the end of the day it's our own personal decision whether we want to focus solely on the mechanical details of the market at work, or believe the ideas that offer explanations for it - and similarly, it's down to preference whether we focus on competitors similar to ourselves, or just on the price and the probabilities.

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  #145 (permalink)
 Big Mike 
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liquidcci View Post
But Mike can you really see what other traders are doing. Market can be seen moving but to me knowing what they are doing is something different.

I am not talking about trying to predict the future.

I am talking about making general assumptions. For example, if the market pushes up slightly above a DT or a prior resistance area, and you see a flurry of orders going off, only for it quickly to close low and fall back down, we can make the assumption that a lot of traders had their stops up there, and that any new long initiated on the breakout will have their stops likely hit if the market continues lower.

So I am not trying to see what any one single individual is doing, but what a collective of people as a whole are doing, generally lumped in as the "dumb money".

That said, we are getting pretty far off-topic which was "Concerning risk per trade sizing".

Mike

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  #146 (permalink)
 Surly 
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Big Mike View Post

That said, we are getting pretty far off-topic which was "Concerning risk per trade sizing".

Another view is that this discussion is very much linked to risk per trade sizing - at least depending on how one defines risk. In a mechanical system such as monpere has nicely illustrated - the risk per trade is $50 or so but the overall risk of using the mechanical system would be based on an estimate of the expectation of the system over any given period of time or # of trades. Of course, for any given mechanical system there is some minimum # of trades required to bring the expectation over that trade series in line with the estimated expectation for the system overall (based on the dispersion).

In any event, if you trading based on discretion where you are not simply following a mechanical system but actually making decisions based on the evolution of market events then it becomes trickier (monpere may say impossible) to establish risk per trade and sizing per trade based on a probabilistic approach.

Here's a question: Is there a way to measure risk that does not involve the calculation of probabilities? Or is risk a concept that only has meaning within the context of probabilities?

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  #147 (permalink)
Griff1
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Hi Everybody

A good topic here, as it is vital to keep losses small and under control, and Position Sizing is the best way I know of......

For those of you who want some extra reading the world Guru on Position Sizing is Van Tharp.

But, as others have already posted, Position Sizing just adjusts the number of lots/Shares/Contracts to keep your initial risk consistent across all your trades. Either by a % of portfolio or a set $ amount, it is the same

I would suggest 1-2% for Futures and Forex and 0.1% to 0.5% for Stocks, are sensible levels

Thanks

Steve

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 Maisie 
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hi there more experienced traders,
a thought occurs to me. in my limited experience it seems that the longer price keeps knocking on a certain door, the more forcefully it ends up moving, whichever direction. if it keeps tapping the resistance, and finally breaks through seems like there's more of a chance of a big bold candle and what i call a "perfect rally" - no overlapping rally candles, and not too many wicks dipping down into the previous body. and conversely, if it keeps tapping on resistance but finally fails, the longer it has tapped the harder it falls. and also, time seems to be a factor. if price moves away from a support/resistance which is *old* it also moves more forcefully. is this my imagination? or known to be a statistical fact does anyone know. because if it is in fact true, you could use that info to size position better according to probability, if you know your old resistance/support levels and have them on yr chart.

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  #149 (permalink)
 jamiej83 
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First of all, wanted to say, good to see traders spending time thinking about one of the most important components of trading - risk management. As a few traders seemed to enjoy my post in "Confessions-" I will add my 2 cents here. Trading is a probability numbers game and the sooner traders accept and embrace this fact, the faster they will develop the mindset required to become successful in this business. Your job as a trader is to become an expert risk manager. Van Tharp, Mark Douglas and FT71 have done some good work in the area of probabilities and respecting the fact that the outcome of each individual trade is unknown using coin toss experiments and random entries. This is very hard for most traders to accept or believe as they have natural biases which are filtered through their belief structure and a strong human need to be right wanting certainty. This is further complicated by the fact that unlike many traditional gambling games the prices (cards) are revealed to all players in advance to make an informed decision. This makes traders mistakenly believe they have an edge on that individual trade rather than a statistical edge over a series of trades. What they fail to appreciate is that all the market players’ actions are unknown after placing their trade, regardless of what they believe their method is telling them regarding the probabilities. The only thing you can control as a trader is your risk (stop loss) and potential profit (targets). The outcome is an unknown variable.

If you read “Market Wizards” you will see that all the traders have their own unique strategies. The common thread is their respect and understanding of risk – this is key. Most of them only got this after blowing one or more accounts. Of course, many traders will read this and think they would never do that and they already respect risk – I beg to differ and let me explain why. In very simplistic terms, as human we are naturally drawn to obtain pleasure and avoid pain. The desire to avoid pain is always stronger and in trading this appears in the form of fears, such as, fear of losing, missing out, being wrong and leaving profits on the table. Once you have entered a position, if you don’t fully ACCEPT the loss on that trade opportunity, knowing that is the cost of finding out if it will work this time or not, you will be acting in a state of fear, whether it be a fear of losing or being wrong. This simple change in belief, transformed my trading as I no longer had a deep burning desire to reduce risk at the earlier possibility opportunity after entering the trade and instead let the probabilities play out. Why was I moving my stop to breakeven and getting trapped out of good winning trades – FEAR!

The only way to know how much to risk, is to first know your OBJECTIVES. This includes a pre-defined risk of ruin. Different traders will have different tolerances to risk and this will also play a part in determining the type of trading that is best suited to their personality – scalping vs swinging. Most individuals can tolerate a 10% drawdown without too much difficulty if they are trading risk capital. Beyond this it will vary depending on the individual. Most traders that I speak to believe they can tolerate much larger drawdowns until they actually experience them! By focusing on reward and not risk, they fail to appreciate the exponential impact and time to recover from larger drawdowns. This is where an understanding of simple statistics can play a big part in a trader’s ultimate success.

Here is a simple example: if a trader has a method which he has tested and found to have an average win rate of 50% and avg win/loss ratio of 2:1, what are the possible outcomes from a series of trades? What would be the average net gain/loss? Average R gain? Largest winner? Largest loser? Longest winning streak? Longest losing steak? Peak drawdown? Average time to recover? Probability of reaching certain drawdowns levels before reaching certain profit levels? These are all simple examples of statistics that you have to know in order to know how much to risk. It is no good reading a book or asking another trader for a generic figure – it is the same as asking to copy another trader’s system – it won’t work in the long run. Everyone has different objectives, risk tolerances, biases etc. Take the time and effort to figure out what suits you and learn some simple statistics. Knowing how many losers you can possibly have in a row, before you should consider there to be something wrong, is very powerful. Most aren’t aware that with a 50% win rate, 10 losers in a row is a possibility. If you are risking 2% per trade, you would be facing a 20% drawdown which may be your ruin point. FT71 did a good example of how increasing risk exponentially reduces the number of consecutive losers you can have before blowing an account. I adapted this, as I thought it would be more useful to know, how many losers I could have before reaching my own pre-defined ruin point, which is 20% annual drawdown (I have attached an example screenshot showing various risks per trade and the number of consecutive losers that you can have before reaching a 20% drawdown). I have pre-set daily, weekly, monthly and annual losses at which point if I hit them, I have to trade SIM for the remainder of that period and I would recommend this for most traders. Realise that if you have a 10% drawdown you need to make 11% to recover, 20% drawdown you need 25% profit, 30% drawdown you need 43%! Most don’t realise this until it is too late, as there comes a point where the odds of recovering becoming slim, so traders take on more risk in order to recover faster, which normally has a negative impact.

One of the most useful exercises you can do to change your mindset to thinking in terms of probabilities is the simple coin toss experiment that FT71 described the other day in his webinar, doing each day before trading. If you flip a heads, give yourself 2pts, if you flip tails, deduct 1pt and keep track in a spreadsheet repeating 100 times. This will simulate as 2:1 reward:risk methodology with 50% win rate. Over time you will notice that your focus shifts from the outcome of each coin toss to the equity curve and drawdowns that are produced. You can then start using that data to look at simple statistics and answering questions such as those I posted above. When you set your objectives first, you may be surprised how smaller % you actually have to risk to reach them, I know I was when I did the work!

When you start to become consistently profitable, you can then adapt your risk depending upon trading performance, however this is an advanced topic and I suggest most traders stick with a fixed % risk until they are able to do that consistently. The reason being is after experiencing a long winning streak, traders mistakenly believe they have mastered it and increase their risk only to see the inevitable drawdown accelerated and they are back to where they started. Only after seeing how they handle the drawdown in their equity curve can a trader realistically think about increasing risk. With regards to recommended %s since many will ask, I see no reason for an active day trader to ever risk more than 1% of their account, and that is at the top end. Most would be far better risking 0.25-0.5% and trading a size where they aren’t attached to the outcome of each trade and use tight stops in an attempt to reduce risk rather than through correct position sizing.

A few quotes that I have written down in my pre-trade plan are as follows to engrain powerful beliefs through consistent thoughts with regards to thinking in terms of probabilities:

1) Accept that trading it is about the ODDS of success over a SERIES OF TRADES (20 trades min) not individual trades – accept the RANDOMNESS of the outcome of individual trades & manage my trades per my plan and I will produce a consistent positive result, same principle rich casinos make money with. The game is being a 1 bullet sniper

2) NEVER hope that a position will go my way or fear that a position will not go my way – both these attitudes lead to unrealistic expectations, emotional decisions and negative attitudes. A position, once established, will result in whatever market action prevails. Once I place my trade, its fate is sealed. No amount of hope or fear will make the outcome any different

3) Only trade my TESTED method flawlessly – be myself, don’t try to trade like anyone else or let others influence me, trade only my beliefs – read my charts, find my edge and trade without hesitation – have a defined risk on every trade and understand that anything can happen

4) “I just WAIT until there is money lying in the corner and all I have to do is go over there and PICK IT UP. I do NOTHING in the meantime. In essence, by not wanting to trade, I have inadvertently transformed myself into a MASTER OF PATIENCE. By forcing myself to wait until there was a trade that appeared so compelling that I could not stand the thought of not taking it, I had vastly IMPROVED MY ODDS” (Jim Rogers)

5) I accept the 5 FUNDAMENTAL TRADING TRUTHS (Mark Douglas):
i) Anything can happen
ii) You don’t need to know what is going to happen next in order to make money
iii) There is a random distribution between wins and losses for any set of variables that define an edge
iv) An edge is just an indication of a higher probability of one thing happening over another
v) Every moment in the market is unique

Hope that gives some of you something to think about and consider.

Trade well
JJ


Trading is: Having the KNOWLEDGE to know when the odds are in my favour, having the PATIENCE to wait for that moment, then having the DISCIPLINE to handle the trade properly when it goes in my favour and properly when it goes against me
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  #150 (permalink)
 Big Mike 
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jamiej83 View Post
The only way to know how much to risk, is to first know your OBJECTIVES

Hi JJ,

Thanks for posting. You might also check out our Risk of Ruin discussion here:


I don't mean to pick apart your post one sentence at a time, but the one above sticks out.

I can define my risk prior to knowing the objective, if I want. My risk is 40 ticks (1R, 1% of account, whatever). There, done.

No clue what chart, time frame, or target -- but I can define my risk

So perhaps you can expand on this a bit so I can better understand your point.

I do agree with your post as a whole, and I always know my risk and target prior to entering a trade. I always calculate my target in terms of reward in risk multiples, and avoid taking less rewarding trades, as my trading style pushes me towards larger reward:risk even at the case of being wrong more often.

I also agree on your Market Wizards statement, and thought the exact same thing when I read the books. The one thing that stood out was they all had different approaches, yet were successful using basic principles of risk and confidence in their approach (confidence built over a long period of trading experience). This helped cement for me it is not about methodology, even though the overwhelming majority of traders focus solely on method and little else.

Mike

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  #151 (permalink)
 jamiej83 
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Big Mike View Post
Hi JJ,

I don't mean to pick apart your post one sentence at a time, but the one above sticks out.

I can define my risk prior to knowing the objective, if I want. My risk is 40 ticks (1R, 1% of account, whatever). There, done.

No clue what chart, time frame, or target -- but I can define my risk

So perhaps you can expand on this a bit so I can better understand your point.

I do agree with your post as a whole, and I always know my risk and target prior to entering a trade. I always calculate my target in terms of reward in risk multiples, and avoid taking less rewarding trades, as my trading style pushes me towards larger reward:risk even at the case of being wrong more often.

Mike

Mike

Thanks for taking the time to read my post and respond with comments. I will also check out the thread on Risk of Ruin. I'm glad you highlighted this point as I probably didn't expand on it enough due to the length of the post and wanting to get across in a succinct way the importance of changing one's mindset to that of probabilities and focusing on the process not the outcome of each individual trade.

You are correct in your thinking that you can always DEFINE your risk without knowing your objectives. However, knowing HOW MUCH to risk is different. Position sizing has 2 key elements - 1) number of ticks risked 2) $ amount risked. Let's say that after conducting your analysis, you have determined that the most efficient way to place protective stops is based on the recent price action, for example, 1 tick beyond the signal bar's extreme, so if entering a long position, you place your protective stop 1 tick below the signal bar's low. Your risk in terms of number of ticks in then known and can be easily defined for each trade before entering a position. The next decision you have to make is how many contracts / lots / shares to trade and this is where the $ amount and knowing your objectives comes into play. Let me explain why...

Using exactly the same system, with pre-determined stops + targets, altering the position sizing alone results in huge variations in the equity curve and will ultimately determine if you reach your objectives or not. Every trader has psychological biases that determine how they respond in different situations and one of the secrets to success in trading is understanding how these biases affect you and using this information to turn yourself into an effective trader. If you try to project what you read or learn from others outside of yourself onto the market, you will have little chance of reaching your objectives. I won't detail all the biases here as the post will be far too long and will lose its impact, but Van Tharp has written the best book in my opinion on position sizing, called "Definitive Guide to Position Sizing". A simple example that most will be able to relate to is the need to be right - this is stronger in some traders than others, and those who are affected by it the most, will tend to favour a methodology where they have a higher win % while sacrificing their average win:loss per trade (R multiple). This is generally achieved through more of a short term scalping methodology and/or scaling out of position to lock in profits as the trade progresses.

So once you have determined the expectancy of your system, what is the optimal position size to give you the highest probability of meeting your objectives? This is probably the most important question you can ask yourself as a trader. Many newer traders believe that it is the one that will you the largest return. Slightly more experienced traders will say it is the largest risk % without going bankrupt. However what hasn't been defined in these scenarios are, "What is your goal? and "What is disaster for you?". Only then can you start to design a position sizing algorithm that is optimal for YOU. First you need to appreciate the exponential impact and difficulty of recovering from large drawdowns as explained in the post. Next you need to ask yourself questions such as - what is your definition of failure (at what point would you quit)? What is your definition of success (what equity increase would delight you)? What probability of your maximum drawdown occurring would you be willing to tolerate? You will then be thinking in terms of risk and what you can psychologically handle while at the same time embracing risk, rather than fearing it when you have an inevitable drawdown.

I will give you a personal example, I define my ruin point where I stop trading as 20% drawdown of my total starting equity - at which point I have to stop live trading for the remainder of the YEAR and move to SIM. This is in my own best interest and is there as a worst case scenario to ensure I remain disciplined in my approach staying sharp, focused and patient enough to wait for only my high probability setups. Trading is my life and my full time business, so of course, I want to do everything I can to ensure that the odds of me reaching this point are very small, ideally less than 1%, so how do I go about this? I break this down into monthly, weekly and daily loss limits. So my monthly loss limit is 6%, my weekly loss limit is 3% and my daily loss limit is 1%. Obviously I need to start off with a risk amount that enables me to have enough losers to still reach my objective before hitting my loss limits. This is where there is a slight difference in discretionary vs mechanical approaches. In discretionary trading, you have an additional component to consider, which has a big impact - emotions. Do you notice any recurring patterns in your equity curve after a string of winners / losers? How are you results affected by the length of time you trade? Do your results suggest you are you better just trading part of the session? How will this affect your frequency? In mechanical trading, for example, the worst thing you can normally do is reduce position size after a drawdown as it will skew the probabilities, however in discretionary trading the reason for the drawdown may not in fact be the system but the trader! All these factors have to be considered.

For me personally, I have determined that I am detailed oriented and extremely focused individual who does best just trading the 1st 2 hours of the session and trying to capture the best 1-2 swings that occur during this time. I experience more frustration and pain from missing the moves than I do from being wrong. I also know that if I have 2 consecutive losers, that my read is generally off and I am better to sit out the remainder of the session and protect my capital for another day. Why is this important? Because now I know the frequency of my setups and their relative statistics I can realistically expect (win %, avg win:loss), I can determine what is a realistic risk % to set in order to give myself the best probability of reaching my objective before hitting my daily loss limit. Therefore I know that 0.5% is an optimal bet size for me per trade, as if I have 2 consecutive losers I hit my daily loss limit and I am done for the day. I also know that statistically I can have around 45 losers in a row before reaching my point of ruin and odds of my system reaching that point are less than 1%. All this has to be considered before I can know how much to risk!

As an additional component for those interested, I will expand upon how I manage trades. This will hopefully further explain why you have to understand your objectives before you know how much to risk. As my objective is to ensure that I capture the main swings from the start of the session in the most efficient way, I often go into a trade small to ensure I am positioned if the market doesn't pullback and the breakout is strong, with the intention of adding to it if I get strong follow through or on the pullback. I therefore will often go in risking less than 0.5%, to give me the ability to add to the position, without ever exceeding my max risk of 0.5% per trade should I get stopped out on the entire position. Under most circumstances, my scale ins will be above my original entry and allow me to move up my protective stop, thereby allowing me to reduce risk anyway, however, under some circumstances the pullback may test my original entry and I need to add at a similar price to my original entry, which wouldn't be possible without increasing my overall position risk if I went in full size when I initiated the position. A little bit deep possibly for the topic being discussed, but I thought it may give some food for thought and question the traditional approach to trade management. As I explained in both this post and the previous one - only YOU know what is optimal for you and you find that out through experience and understanding your psychology and making it your edge. Believe nothing, question everything and test it for yourself, only then will you have confidence in your own approach and ability knowing it has a statistical edge and is in alignment with your beliefs about the market.

I could elaborate a lot further on different risk models, but I suggest traders read the work from Van Tharp if they would like to understand it more indepth. The only thing I would add is that altering risk % based on your equity curve is an advanced topic and should only be done by those with a consistent track record otherwise you may be increasing risk after an extended winning streak only to accelerate the drawdown that follows. Most traders have their biggest drawdowns shortly after their biggest winners, so this can be counter-productive. Instead you have to understand and see how you handle the drawdown that follows before considering increasing your bet size. Tracking your equity curve, and altering your bet size based on how you would trade the market can be a useful exercise for advanced traders to further enhance their profitability. An example, would be increasing your bet size after a strong BO and PB, while the equity curve is in an uptrend making HHs and HLs. Again something else to consider for those traders at this level. Same can be done to the downside to reduce risk when your trading may be going through a difficult stretch.

Trade well and feel free to ask questions
JJ

Trading is: Having the KNOWLEDGE to know when the odds are in my favour, having the PATIENCE to wait for that moment, then having the DISCIPLINE to handle the trade properly when it goes in my favour and properly when it goes against me
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 monpere 
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Big Mike View Post
Hi JJ,

Thanks for posting. You might also check out our Risk of Ruin discussion here:


I don't mean to pick apart your post one sentence at a time, but the one above sticks out.

I can define my risk prior to knowing the objective, if I want. My risk is 40 ticks (1R, 1% of account, whatever). There, done.

No clue what chart, time frame, or target -- but I can define my risk

So perhaps you can expand on this a bit so I can better understand your point.

I do agree with your post as a whole, and I always know my risk and target prior to entering a trade. I always calculate my target in terms of reward in risk multiples, and avoid taking less rewarding trades, as my trading style pushes me towards larger reward:risk even at the case of being wrong more often.

I also agree on your Market Wizards statement, and thought the exact same thing when I read the books. The one thing that stood out was they all had different approaches, yet were successful using basic principles of risk and confidence in their approach (confidence built over a long period of trading experience). This helped cement for me it is not about methodology, even though the overwhelming majority of traders focus solely on method and little else.

Mike

We have to differentiate between 'Dollar Risk' and 'Stop Risk'. Combine the two to get appropriate position sizing using Van Tharp position sizing formula: Size = DollarRisk / StopRisk.

monpere View Post
...
We must also make the distinction between the terms 'risk', and 'stop placement'. They are not the same thing. A trader may arbitrarily choose how much money they are willing to lose on a trade (dollar risk), but should not choose his stop placement based on that dollar amount to be risked. What he should do first is determine his stop placement according to market structure. Then, size the trade appropriately based on the size of that stop loss (stop risk) in order to stay within the acceptable dollar amount he is willing to risk.


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