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FT71's Price Risk vs. Information Risk argument
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FT71's Price Risk vs. Information Risk argument

  #11 (permalink)
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I too was trying to get my head around this exact question. Al brooks sometimes waits for a few "large trend bars" in the direction of the trade before committing to an entry. This seems like a lot of price risk, but he clearly believes he has the biggest edge (and therefore smallest risk) at this point. It seems that a strong move in a direction increases the probability for the move to continue. Almost like the saying "the most profitable part of a trend is the middle" and "donít try and pick tops and bottoms" . These statements clearly state that you should take price risk. I believe his idea is to almost follow institutional type order flow, so inherently the market needs to move first.

Conversely from a mathematical basis it makes no sense to take much price risk at all. For example if a breakout bar (or a bar that has bounced off/tested an area of S/R) is 10 ticks tall and you expect a move of 20 ticks (where you put a profit target for instance). If you enter on a order 1 tick above the bar, with a stop 1 tick below (al brooks style) you have around about a 2:1 risk to reward trade. The same trade that is entered with a market order as the bar is forming - say 5 ticks away from the S/R line - and has a stop in the same place, with the same 20 tick profit target, has a 4:1 R/R. That set up is now "supposedly" TWICE as profitable and therefore you can be wrong twice as much as al brooks and still make the same money (if you agree al brooks is indeed making money).

If you took it one step further and put the profit targets at exactly the same price level, then the market order trade would in fact have a 25 tick profit target giving a 5:1 R/R (because the entry was taken 5 ticks earlier the profit target/price level is 5 ticks further away)

For the conclusion, al brooks must believe that taking the 2:1 trade on an order above the bar must have more than TWICE the true probability of success than taking the 4:1 trade, otherwise he is throwing money down the drain

Or maybe it simply comes down to trader psychology...all setups will be successful with a 33%, 20%, 16% win rate respectively. SO maybe al brooks prefers feeling right more of the time

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  #12 (permalink)
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heavyhucks View Post
Or maybe it simply comes down to trader psychology...all setups will be successful with a 33%, 20%, 16% win rate respectively. SO maybe al brooks prefers feeling right more of the time

I've been in Al's trading room and read his books, and he does say that he much prefers a lower reward for a higher strike rate. He said that enjoying your work should be important, and he doesn't enjoy taking many losers, so is happy with low R, higher probability trades over higher R, lower probability, even if he knows that the net return from the higher R trades may be higher. It comes down to what matches your personality. Some people love the buzz that comes from a 5R, even 10R trade (who wouldn't?), but what they must also learn to endure is many, many smaller losses to offset those large wins.

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  #13 (permalink)
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I used to trade with a high price risk and have since switched to low price risk/high information risk trades and have seen my success increase greatly.

With a high price risk I was waiting for confirmation off of S/R and trend lines before entering the trade. But by the time I felt it had been confirmed it created a poor stop situation. I was either forced to place my stop in the middle of no man's land and risk being taken out by a minor pull-back. Or, I was forced to enter a much bigger stop than I would like, leading to huge losses. This leads to frustration as often I would get stopped out by my small stop or the support/resistance line would fail and I would end up taking a much bigger loss than I would have liked.

Now, with informational risk I will place a limit order (or just watch and place a market order) right at S/R lines. This gets me in at a better price with a lower monetary risk because I know quickly if I am wrong. I can enter a much smaller stop and only risk a portion of what I was risking before.

The key here is accepting that you will be wrong. I will gladly accept a lower monetary risk knowing that I will be wrong, and often, no matter where I enter.

My Sierra chart stats for the last 30 days say I'm right on 51.1% of my contracts, not great. My average profit factor is 1.43.

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  #14 (permalink)
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Looking to continue this discussion

Mike

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  #15 (permalink)
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Thanks for the bump Mike - I was not aware of this discussion but it is a constant issue for me.

I am torn between two different entry methods - one with price risk and one with information risk.

Generally, I enter on pull backs in the intraday trend looking to scalp the majority of the each measured move. I mostly take entries only with price risk as in theory in my experience this significantly increases the win rate at the expense of the size of the measured move that you can perfectly capture.

It also reduces my tendency to try to catch falling knives by at least waiting until price moves some way in your direction you significantly increase the potential for further desirable price movement.

By price risk for me I mean entering on at least a 4 or 5 tick move back in the direction of the trade.

The alternative information risk option is to trust my ability to identify support and resistance levels via volume profile, fibs, swing hi/lows and simply enter with limits as close as possible to the level. This then gives me an option to keep my stop at an area where I know I'll be wrong and can also mean that I can take a part off after the bounce off the level moving my position to break even if I take a full stop out and means I can sit back and let the 2nd part develop with less stress.

That's the idea. The problem with the information risk option is that it does generally require a higher level of experience and analysis to consistently choose the levels where there will be a bounce.

My problem lately with using price risk is that I keep getting stopped out but then immediately re-enter because the trade is still valid - this then sometimes happens 4 or 5 times in the same setup when I could have been in the one trade and already taken 1/2 off waiting patiently for part two to hit my target.

EDIT: It occurred to me after writing this that maybe my stops are simply too tight.. Hmmmmm


Last edited by fibfisherman; June 21st, 2012 at 10:43 PM.
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  #16 (permalink)
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Wanted to share the origins of this phrase "Price risk vs Information risk", as per @futuretrader:


futuretrader View Post
No, the distinction comes from Justin Mamis' excellent book, The Nature of Risk: Stock Market Survival and the Meaning of Life.
Amazon.com: The Nature of Risk (Fraser Publishing Library) (Contrary Opinion Library) (9780870341328): Justin Mamis: Books

I believe FT71 recommends it on his website as well.

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  #17 (permalink)
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I went ahead and bought the book

Amazon.com: The Nature of Risk (Fraser Publishing Library) (Contrary Opinion Library) (9780870341328): Justin Mamis: Books

Since I am always looking for books on risk, and it received excellent reviews. I plan to read the Keppler book on Profile's that I've been discussing in the VP thread first, but will try to come back and share some thoughts on Justin Mami's book afterwards.

@Fat Tails, have you read this book? You have the biggest library of anyone I know.

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  #18 (permalink)
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[QUOTE
My problem lately with using price risk is that I keep getting stopped out but then immediately re-enter because the trade is still valid - this then sometimes happens 4 or 5 times in the same setup
QUOTE]

One of the little nuggets I picked up from FT71's webinars is that you have to define how many time you have to be wrong in one direction for you to concede that maybe you are trading against the major move. So in your case, don't you think 4-5 times entering a trade in the same direction and getting stopped out is an indication of "maybe I shouldn't be going long/short?"

Just my 2 cents.

Kulu

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fibfisherman View Post
My problem lately with using price risk is that I keep getting stopped out but then immediately re-enter because the trade is still valid - this then sometimes happens 4 or 5 times in the same setup when I could have been in the one trade and already taken 1/2 off waiting patiently for part two to hit my target.

EDIT: It occurred to me after writing this that maybe my stops are simply too tight.. Hmmmmm

If you get stopped and immediately re-enter the same direction, then your stop is in the wrong place. If the trade is still valid enough for you to immediately re-enter, then the trade is still valid enough for you to have not exited in the first place.

Too many people set a static stop like "10 ticks" because of a pain threshold. Market couldn't give a flip about that. Your stop should be set to the point where the trade idea is no longer valid, and you will admit that the original trade direction was wrong. You certainly don't want to re-enter immediately in the same direction.

You probably are not practicing patience with your entries, and are trading in the middle of no where instead of having price come to you. This means your stops are asymmetric to your target, the wrong way.

The other possibility is that your trading the wrong product or class of products, with the wrong position size, and you feel that you have to have this small stop because of the amount of $$$ on the line. The solution would be to risk no more than 1% of your account with any single trade, and to adjust your product/class/size so that you can do this. This might mean stop trading futures, or at the very least, only trade micro CME FX.

Last, a lot of traders go and trade smaller and smaller charts, trying to minimize the pain of a stop. They view big chart = big stop, small chart = small stop. The problem is, small chart = noise, random movement, much harder to execute an edge on a smaller chart in my opinion. Solution (imo) is to trade a bigger chart, bigger time frame, with smaller size, or if needed a different product class (micro's, spot forex, etf's, whatever) to maintain the 1% risk maximum.

Mike

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  #20 (permalink)
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Big Mike View Post
I went ahead and bought the book

Amazon.com: The Nature of Risk (Fraser Publishing Library) (Contrary Opinion Library) (9780870341328): Justin Mamis: Books

Since I am always looking for books on risk, and it received excellent reviews. I plan to read the Keppler book on Profile's that I've been discussing in the VP thread first, but will try to come back and share some thoughts on Justin Mami's book afterwards.

@Fat Tails, have you read this book? You have the biggest library of anyone I know.

Mike

@Big Mike: No I have not read this book.

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