I did not say I believe in trading a certain percentage of your account. I believe that is purely arbitrary, and depends on the size of your account, and how risk averse you are. And I do not believe risk should be dtermined by how much you can afford to lose. As I said, I use the R-Multiple method "Shares = RiskDollarAmount/StopSize. Keeping RiskDollarAmount fixed, when StopSize increases, then Shares decreases, and vice versa." You are adjusting your contract sizing based on the size of your stop to keep your dollar risk constant.
In this equation, although the dollar amount you are risking is fixed, and maybe based on what you are comfortable on losing, that is not the basis of your stop loss. The actual technical basis of your Risk, is StopSize, because it is the only variable in the equation. With this method, you may take one trade with a 10 tick stop, and a 2nd trade with a 50 tick stop, and if you get stopped out on both trades, you will have lost the same amount of money on each of these trades. So, even though you limited your dollar risk to a fixed amount, you did not limit how and where you place your technical stop in the market.
Since you mention the ES, Put the RiskReward indicator on an ES chart, and put lets say $500 in the 'DollarRisk' parameter field, and 0 in the 'FixedPositionSize' field. Now go to the chart, select the stop line and drag it up and down closer and farther from the entry line, and observe how the number of contracts changes to keep your loss to a maximum of $500, as your stop size changes.
Last edited by monpere; February 19th, 2012 at 08:50 AM.
The following 2 users say Thank You to monpere for this post:
Indeed, every trade carries the same amount of risk from a probability standpoint. I don't have any idea ahead of time, if one trade has a better chance of being a big winner, than another. So they are not sized, based on any expectation of profitability. The majority of the time, the same goes for adding to my winners. Even though I have a better "feel" for the trade once it is working, my add is still based on an algorithm, and not on discretion. However, there are special times when I do lever up, when I can readily see the trade is spot on.
While every trade is treated the same as far as expectancy, not every market is treated the same. You can't treat this years market, and it's attendant volatility, the same way you treated last year's market, and it's attendant volatility, any more than you can treat two different instruments, with two different vols, the same.
So, even though my stops are discretionary, and ultimately based on where-I-don't-want-to-be-in-the-position-anymore, they are still placed within the context of a volatility-based, position sizing algorithm, which is quite simply, 2% of equity risk, based on a 1.5 ATR stop. This allows me to have a realistic expectation of my risk/reward based on the current volatility of the market and the current volatility of the instrument I’m trading.
What’s most important is what you make of the trade once you have it on. It’s not about, how often you right the market , rather than how much you are right the market. Not only are my winners bigger than my losers, but my winners are ultimately sized bigger and held for a considerably longer time.
Last edited by tigertrader; February 19th, 2012 at 10:59 AM.
The following 3 users say Thank You to tigertrader for this post:
In the last analysis, we can see judging from the various opinions that it is a matter of common sense as in everything else in life. If you start with a bank of $10000, it does not take lots of analysis to determine an acceptable risk. It would probably be equal to 2% of this capital. Once you have determined an acceptable risk, you look for a method or approach you know will present opportunities in line with that risk size. You would not pass your time to calculate a new risk size after each trade. Most probably you will trade with the same figure +/-. When your bank increases say by another +$3500 or +$5000, you'll not necessarily change the risk size, you may just continue what you were doing or decide to add one more contract. It's just a personal choice and possibibly your "greed threshold" (the amount of money one feels they are entitled to by virtue of their intellectual or physical assets). That said, i realise since i trade the Futures markets, i think less in terms of fixed % but more in terms of what i am comfortable to risk at that point in my trading life while being aware of my financial resources and status.
The following 2 users say Thank You to trendisyourfriend for this post:
tigertrader, You seem to be an experienced trader with many years of market experience. You may have well developed an instinctual feel or method that has brought you outside of the bell curve. But for the majority of traders reading these forums trying to become profitable, adapting the style of sizing trades based on which one they think or feel will have better chance of winning, go further, or run longer, will generally not work in their favor.
Obviously your post was very personal, and you are describing your trading as it relates to your skill level and experience. My view is that R-Multiple share sizing is a safe way of generically controlling risk, and any trader at any skill level can start using that method at market open tomorrow. Would you advise the average trader on this site to size trades the way you do? Do you believe they will control their risk better if they attempt to do what you do based on what you described in your post? Or, are you just saying that it is possible to successfully size that way, but only with the proper market experience, skill and/or instinct?
Last edited by monpere; February 19th, 2012 at 11:54 AM.
No, I agree with you - my methodology is not for novices, and may indeed be classified as a"don't-try-this-at-home" trading style. However,( IMO) at some point in time, when a trader is at a more intermediate to advanced level, and wants to take his trading to the next level, it is the methodology to take you there.
The following user says Thank You to tigertrader for this post:
Interesting article. I didn't fully grasp all of it, due to it's rather theoretical nature, but here's the defining paragraph that stood out to me in the entire article:
"Poundstone highlights another important feature of the Kelly system: the returns are more volatile
than other systems. While the Kelly system offers the highest probability of the most wealth after
a long time, the path to the terminal wealth resembles a roller coaster. The higher the percentage
of your bankroll you bet (f from the Kelly formula) the larger your drawdowns."
Last edited by monpere; February 19th, 2012 at 10:29 PM.
The Kelly formula requires the average trade, because the Kelly formula was derived from gambling using fixed outcome p'n'l rather than in trading where the p'n'l is variable. It significantly underestimates the optimal fixed fraction. There are many reasons why you wouldn't want to use the optimal fixed fraction though, so perhaps the Kelly formula is better since it's less aggressive. If you want a good intro to the theory, the first chapter of Ralph Vince's Mathematics of Money Management is good. I can't recommend the whole book. He writes a lot like Al Brooks writes - difficult to read!
You can discover what your enemy fears most by observing the means he uses to frighten you.