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

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FT71's Price Risk vs. Information Risk argument

I've just watched FT71's superb webinar on Risk Webinar: FuturesTrader FT71 on Risk, Sizing, Scaling and Trading Probabilities

I've created a new thread because I think that thread was already cluttered and I wanted to focus on this one aspect of the webinar. If you haven't watched it, I would recommend you grab a cup of tea, sit down quietly with no distractions and watch it (and take notes).

I'm currently studying Al Brooks and he advocates using stop orders to enter the market when you are not in a trading range, so that you get "swept into the market" with the direction of the market. It seems then that Al is paying for the privilege of information and is willing to take price risk instead of information risk. If he was taking information risk then he would enter the market with a limit order. FT71 is saying that most professional traders will take information risk over price risk, a concept I found interesting.

Now, Al Brooks says that entering on a stop order (when not in a TR) is a higher probability trade over entering on a limit order. There seems to be a conflict here in my eyes, or am I missing something? I do realise that if you take information risk then you are sacrificing probability for a better risk/reward trade because you are entering nearer to where you will be wrong. However, if you take price risk, you enter further from where you are wrong and thus need a larger stop but the probability over a series of trades will be higher when taking price risk. So, in my eyes, it would seem psychologically EASIER, even though over a series likely less profitable, to take price risk over information risk. The result being in a higher win rate (easier for the monkeys in us), but the sacrifice of lower R, or profit over the series. I see the benefit of information risk, but for newer traders, I think I am leaning towards price risk. I would love to hear what FT71 or what highly experienced consistently profitable traders have to say on this issue.

I do understand fully what FT71 is saying, but I think I would prefer to take price risk as a beginner trader. Is this a good strategy for someone new to trading? I've only been trading part-time for five years.

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keymoo View Post
I do understand fully what FT71 is saying, but I think I would prefer to take price risk as a beginner trader. Is this a good strategy for someone new to trading? I've only been trading part-time for five years.

Hi Keymoo,

I think your answer cannot be answered so easy. It more depends on your strategy you as focusing on and the risk you are willing to take. Lets say you are looking for a pullback trade in a bullish trend. Profesional traders would (according to FT71) enter with a limit buy order in a pullback at a certain level and take the information risk. Retails traders tend more to wait for a confirmation (price advancing to the prior high) before entering the market. I think it all depends on the risk you are willing to take.
I did not read Al Brooks but if he is entering the market with a stop order, Im assuming that he sets his stop buy order at the prior high or before it. So for me taking information risk (limit buy order) in this example instead of price risk (buy stop order) has a clear advantage as your risk is lower in the first case (assuming that we place the stop loss at the same level). But I heard from a professional trader that placing a buy stop order before the prior high in this example and trading the breakout above the prior high is also a common tactic. It depends on your assumption if the trend will continue or if it is more likely that he will slowing down.

If I remember well FT71 said in one webinar that he also looks at the price movement at his levels of interest and if price is slowing there before entering the market in the opposite direction.

So it all comes down to your assumption what the market is doing and your risk management.

Best regards,

Malvolio

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keymoo View Post
I've just watched FT71's superb webinar on Risk Webinar: FuturesTrader FT71 on Risk, Sizing, Scaling and Trading Probabilities

I've created a new thread because I think that thread was already cluttered and I wanted to focus on this one aspect of the webinar. If you haven't watched it, I would recommend you grab a cup of tea, sit down quietly with no distractions and watch it (and take notes).

I'm currently studying Al Brooks and he advocates using stop orders to enter the market when you are not in a trading range, so that you get "swept into the market" with the direction of the market. It seems then that Al is paying for the privilege of information and is willing to take price risk instead of information risk. If he was taking information risk then he would enter the market with a limit order. FT71 is saying that most professional traders will take information risk over price risk, a concept I found interesting.

Now, Al Brooks says that entering on a stop order (when not in a TR) is a higher probability trade over entering on a limit order. There seems to be a conflict here in my eyes, or am I missing something? I do realise that if you take information risk then you are sacrificing probability for a better risk/reward trade because you are entering nearer to where you will be wrong. However, if you take price risk, you enter further from where you are wrong and thus need a larger stop but the probability over a series of trades will be higher when taking price risk. So, in my eyes, it would seem psychologically EASIER, even though over a series likely less profitable, to take price risk over information risk. The result being in a higher win rate (easier for the monkeys in us), but the sacrifice of lower R, or profit over the series. I see the benefit of information risk, but for newer traders, I think I am leaning towards price risk. I would love to hear what FT71 or what highly experienced consistently profitable traders have to say on this issue.

I do understand fully what FT71 is saying, but I think I would prefer to take price risk as a beginner trader. Is this a good strategy for someone new to trading? I've only been trading part-time for five years.


Your entry method has nothing to do with price risk, information risk, or whatever risk, that's a curious concept???. Your entry method should be chosen based on your trading methodology. First, for a given price in the market, a stop order, and a limit order are placed on different sides of that price, that itself defines different market approaches. For any trade, an order on one side of the market says you have more of a breakout approach, on the other side means you have more of a pullback approach. Not sure how that relates to this abstract price/information risk concept.

If you are trading a 60 min chart with a 40 tick stop, looking for a 100 tick moves, then for a normal liquid market with 1 or 2 ticks average slippage, then a market order should be no problem. But if you are scalping the same market with a 4 tick stop 8 tick target, then 2 tick slippage is horrible, because the slippage itself is such a large percentage of your target. In this case you want to absolutely enter with a limit order. In this latter case supposing on a losing trade you get 2 ticks slippage on the entry and 2 tick slippage on the stop, you just got a losing trade of 8 ticks. You are suddenly trading at 1:1 risk/reward, even though you are trying to trade a 2:1 method. That 4 tick slippage in and out is inconsequential if you are trading 2:1 risk/reward with a 40 tick stop 80 tick target. In terms of entry method, I think there are more concrete criteria that should determine a traders entry technique.


Last edited by monpere; April 8th, 2012 at 08:47 AM.
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monpere View Post
Your entry method has nothing to do with price risk, information risk, or whatever risk, that's a curious concept???

Did you watch the webinar?

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Did you watch the webinar?

Mike

Yes, and I agreed with much of it, but this is my opinion on this particular point.

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@monpere, I think you are assuming that the trading methodology is already determined. But, to use your example, the choice between a pullback method and a breakout method (assuming these are different entry points in the same potential move) already involves a trade-off between price risk and information risk.

@keymoo, if you are a beginning trader and are consistently profitable with either approach you are doing very well! If not, you are better off to focus on limiting risk, rather than on maximizing profit or on psychological comfort.

The discussion of price risk vs information risk comes from Justin Mamis, whose book is worth reading, though it definitely isn't filled with practical suggestions. It isn't about a choice between limit orders and market orders.

FT71 does not (or rarely does) enter on a limit order simply placed at a level, he waits for price to reach an area, then looks more closely at price action and the DOM to make his decision. So he is actually gathering further information that (in the case of the DOM) Brooks does not use. What he doesn't do is to wait for price to 'confirm' what he sees.

Waiting for price confirmation is definitely psychologically easier, which is why most people wait for it. It's also psychologically easier to cut winners short and hold on to losers, and to average down, and to do all the other things that people do on the way to blowing accounts. Doing what feels best on individual trades is a good way to feel very bad at the end of the day / week / month.

Confirmation also takes many other forms - more and better indicators, intra-market correlations, adopting gurus' methods, joining trading rooms, etc. All of these can be useful; none of them can solve the basic difficulty of discretionary trading, which comes down to you having the necessary confidence, skill, and experience to execute your method as well as you can.

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futuretrader View Post
FT71 does not (or rarely does) enter on a limit order simply placed at a level, he waits for price to reach an area, then looks more closely at price action and the DOM to make his decision. So he is actually gathering further information that (in the case of the DOM) Brooks does not use. What he doesn't do is to wait for price to 'confirm' what he sees.
.

There is a very good reason for doing this on the ES and not doing it on other markets.

Fact is, if you are really good at reading the DOM and you can often see the exact point that a move down is cut off, then you simply cannot use a limit order because you will not get filled.

Now - this is a bit different from waiting for the price to move your way and entering on a stop. It's still waiting for the market to come to you but refining the entry with reading the order flow.

On thinner markets, you can do the same thing and use a limit order, even put your limit order a few ticks better because on those markets, the chances are the higher volatility will see you getting in. On the ES, you might see price come down in a pullback in an uptrend and see thousands of contracts hit the bid and it all getting absorbed. This is the place, this is the best price. Trouble is, there might be 2000 contracts in front of you and if you are right about the spot, your chances of getting a fill are zero. So you hit the offer (or put in a market order) and take the best price available which is a tick worse.

Unless you are the guy absorbing the 1000's of contracts to halt the pullback, I don't think there's a better price that you can realistically get.

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Great discussion. Determining how much you will pay (price risk) in order to get more info is a very important aspect of trading. Although Futuretrader's comment is correct in that I don't just put orders out there and wait for them to get filled, I also believe that it is inaccurate that I'm trading price risk for information risk in this scenario. Coming into the day, I have already answered the key questions to form my hypothesis (what I expect the market to try to accomplish for the day). In fact, I post this for everyone in the chat room to question, discuss and follow up on later. So I am clear about what my areas of interest are.

However, I don't put limit orders out there because I am refining my entry price based on my experience having traded for so long. It isn't really price risk anymore at that point, it is simply about getting a sharper point of entry. The truth is, the end result is probably the same as if I had put a limit order out there assuming nothing in the most recent auction and price action has changed the likelihood of my hypothesis working.

As someone who is yet working on making the turn in trading, I would emphasize more effort on mechanically executing the trade once you have decided where you want to enter. This is KEY. A trader ought not try to outsmart his/her trading plan (if he/she has one) by micro-managing the trade once it is on. You have determined that you would sell 1382.50, so you sell 82.50 and then MECHANICALLY place your target, stop and scaling prices. That's one of the key elements of the coin toss that I put my former traders through.

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info vs. price risk


Another way to describe the difference between price risk and information risk is in terms of where you think you have the biggest advantage or edge. If you are more confident that your information gives you an advantage, then you can absorb more information risk in your execution (i.e., get in sooner at a better price, before you have confirmation of the market moving in your direction). If you are not as confident in your information (homework and analysis) then you cannot absorb as much information risk with your execution and need to take on less information risk by exchanging it for more price risk (i.e., get in later at a worse price after the market has begun to give you confirmation that your hypothesis is correct).

If you think about it, if you knew you had 100% information (i.e., no information risk at all) then you could take 100% information risk trades and would theoretically have 0 price risk and never take heat.

I believe (not to place words in his mouth) that FT71 is more confident of his homework (analysis) and so is willing to get in when there is high information risk (more uncertainty that his hypothesis is correct) but low price risk. If you watch some of his website's videos you can see that he gets in early as soon as price slows down at his level and talks a lot about the problem with waiting for confirmation before entering.

hope this helps.

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