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Concerning risk per trade sizing
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Concerning risk per trade sizing

  #31 (permalink)
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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!


I have Mathematics of Money Management on pdf. - Anyone interested in reading it can PM me for a copy.

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  #32 (permalink)
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I am primarily a stock trader and I've found that it is easier to control risk trading stocks than trading futures, since stock position sizes are more scaleable.

My basic approach is to allocate about 10% of capital per trade. The impact on the total account is thus 1/10 of the movement of the underlying stock. If the stock loses 10%, my account loses 1%. My "worst case" stop loss on any individual trade is 40%, or 4% of the total account.

As the account grows, I will look to decrease the allocation of capital per trade so that the risk per trade falls closer to 2%. There is a tricky balancing act involving risk vs. the number of trade signals generated per day vs. commissions (the less capital you devote per trade, the greater the proportional share of commissions you wind up paying) that I'm working through but for now the 10% allocation is working okay.

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  #33 (permalink)
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One can try a lighter version,

The Trading Game - by Ryan Jones.

Harvest The Moon
Nest The Market
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  #34 (permalink)
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Monpere, et al.

A conclusion that can certainly be drawn from our discussion is; the whole question of risk management is far from an objective subject. You need at least one subjective piece of the puzzle to put it together, and that is an individual’s tolerance to risk. Now that is subjective, meaning there is no rule that says how risk averse you should be. That is an integral part of your emotional makeup.

The problem is, human nature does not operate to maximize gain, but rather to maximize the chance of gain, i.e., maximize the the number of winning trades, and minimize the number of losing trades. The result is, not only is risk controlled, but profitability is also controlled. In other words, playing it safe can be just as bad as taking too much risk, because you are not optimizing your winning trades nor the days with expanded ranges.

Sure, it's possible to devise trading schemes based on very short-term price swings that will on average be profitable. However, the average profits on individual trades from such methodologies are miniscule, and the trades they generate are so frequent that it not feasible to scale these strategies. If you look at it from a (modern portfolio theory) point-of-view, you can think of the trading profit on any given trade, as the compensation you receive for the risk you took on the trade. In a sense, the market demands a premium from the trader for taking less risk, which is of course, reduced profitability

As Michael Moubassin pointed out above, "Substantial empirical evidence shows that price changes do not fall along a normal distribution. Actual distributions contain many more small change observations and many more large moves than the simple distribution predicts." The ramifications of this observation are that not all markets should be treated the same and not all trades should be treated the same. The individual days and individual trades, which I like to call "special" must first be recognized and then they must be taken advantage of to the fullest extreme. It is far worse to miss taking advantage of a special trade than to make a bad trade, and it is just as bad for your P&L to fall into it's normal distribution of returns, on a day with 3XATR, as having a bad day.

Traders take risk, in the sense they routinely make judgements whose outcomes are uncertain. So it would follow then, that good traders don't try to eliminate risk as much as manage it, and intsead, can increase their chance of profitability by better reducing that uncertainty. This can be accomplished by making better trading decisions than those that are less informed, less knowledgeable, and less skilled. Ultimately, it is not what the trader knows, but who he is. The really profitable traders are able to ignore or subvert their natural tendencies to do what feels comfortable, and instead, do what is necessary, to be optimally profitable.


Last edited by tigertrader; February 21st, 2012 at 10:17 AM.
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  #35 (permalink)
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Going along with tiger's last paragraph, I feel that traders all too often try to eliminate and reduce risk as opposed to trying to embrace and manage it. Powerful difference between the two.

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  #36 (permalink)
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There you go tigertrader...

sharing the secrets of the great mystics. I got a great chuckle out of how well written the post is. Absolutely what I learned too (the hard way)...but in way, way nicer language.

I was alluding to the same thing in my post #2 of this thread but I was trying to keep it as simple as possible.

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  #37 (permalink)
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wldman View Post
sharing the secrets of the great mystics. I got a great chuckle out of how well written the post is. Absolutely what I learned too (the hard way)...but in way, way nicer language.

I was alluding to the same thing in my post #2 of this thread but I was trying to keep it as simple as possible.


Thank you, my friend !

Unfortunately, you and the chair, are in the rare minority,(especially on this forum) that get it.

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  #38 (permalink)
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wldman View Post
sharing the secrets of the great mystics. I got a great chuckle out of how well written the post is. Absolutely what I learned too (the hard way)...but in way, way nicer language.

I was alluding to the same thing in my post #2 of this thread but I was trying to keep it as simple as possible.


Glad my methodology does not require me to be 'a great mystic' in order to make money... just joshing you guys

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  #39 (permalink)
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monpere...

it is hard to communicate clearly sometimes in a medium like internet forum.

I'm sure that if you are continuing to trade real money on a daily basis that you are in fact a great mystic...or at least great mystic eligible.

The idea of risk reward is very complex and the approaches to it almost infinite. What works well enough for any individual should , I guess, be left alone.

I was just making fun of tigertrader's "nice" description, confirming with him that it is not how we "learned". I meant no elevation of one here over another or to create any other implicit conclusion.

To me it does seem insane to define risk the way most here seem to. Briefly...to systemically define a maximum...doesn't that then become the "typical"? I understand how and why that develops...my wish was to prod just a few guys past that thinking. I do not want to seem arrogant in that but I believe that "discovery" if it is to happen, has to be that of they person searching...not because wildman or tigertrader or anyone else said so.

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  #40 (permalink)
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wldman View Post
it is hard to communicate clearly sometimes in a medium like internet forum.

I'm sure that if you are continuing to trade real money on a daily basis that you are in fact a great mystic...or at least great mystic eligible.

The idea of risk reward is very complex and the approaches to it almost infinite. What works well enough for any individual should , I guess, be left alone.

I was just making fun of tigertrader's "nice" description, confirming with him that it is not how we "learned". I meant no elevation of one here over another or to create any other implicit conclusion.

To me it does seem insane to define risk the way most here seem to. Briefly...to systemically define a maximum...doesn't that then become the "typical"? I understand how and why that develops...my wish was to prod just a few guys past that thinking. I do not want to seem arrogant in that but I believe that "discovery" if it is to happen, has to be that of they person searching...not because wildman or tigertrader or anyone else said so.

I know exactly what you mean. Obviously there are some very successful traders here who have a natural innate sense of the market, or have develop that sense over their spectrum of experience. I am glad that tigertrader qualified his methodology as 'not for beginners', because most participants on forums like this are traders who are seeking a way to success. My aim is to help them reach that goal by using safe and consistent risk management that will allow them the time to learn and gain enough experience to become successful before reaching their risk of ruin point.

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