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Never. After 2 losers you are down to 64% of capital. 1 winner can only get you back to 96%. Its a losing system in the long haul. Long drawdowns give even more dramatic destruction.

Travel Well

The following user says Thank You to ratfink for this post:

I think he means 50% of your 'capital invested'. Capital invested could be something like 2% of your total account equity. So in fact, this is a free lunch opportunity if you could trade it forever. If this is hard to imagine just mathematically, you can just see the Monte Carlo simulations that I generated and nearly all of the equity curves end up in the positive after 1000 bets.

The following user says Thank You to artemiso for this post:

Mike,
I don't think that you meant it, but people can be divided into 3 groups:
1. Risk takers - will take a bet even when the odds are against them. less then 50% with 1:1 risk reward
2. Risk indifferent - will take a bet even when the odds are equal.
3. Risk avert - will take a bet only when the odds are on their side.

Im glad you guys are involved in this thread..... i shall watch and see what matures from this discussion

Risk vs reward Imo is the wrong approach because algos could/are physiological programmed, remember retail doesnt matter big fish eat small fish too.

probabilities of success is all that matters

@Big Mike to answer your question i trade both ways you mentioned. We are programmed the same to take the same bet/bait/trade even when its the wrong one, so then probabilities come in to play with ones system. I am no longer discretionary with my setup

This is now how I (or anyone I think) defines risk aversion--it is defined as preferring lower risk. It does not say anything about probability of winning, thus odds; it only speaks of losing (hence, risk).

So for example, a risk averse person might choose to put his money in bonds, even if he receives sound investment advice that he is 80% certain to double his money this year in equities, because even with an 80% win probability (as far as he can quantify), the 20% chance of losing scares him enough to take the less risky bond route, despite the maybe 10:1 payout prospects in equities versus bonds.

Last edited by josh; February 21st, 2013 at 04:06 PM.

@artemiso: I had asked this question because there is a catch. It is not a free lunch, but just another road to disaster. The problem lies in adjusting your bet size to the size of your account. I will try to explain, why the scenario

ROC of 50 % with a probability of 1/3
ROC of - 20% with a probability of 2/3

will deplete your account in the longer run.

The main problem lies in adjusting the investment (or bet size) to the size of your account. If your stake is $ 100.000 then your investment and your returns are smaller than if your stake is $ 200.000.

Fixed fractional betting means that you need to adjust the size of the bet to the size of your account. This will basically maintain your proportianal risk of ruin at a constant level. It also means that you do not

- increase leverage after a loss
- decrease leverage after a win

but that you always put the same fraction of your account at risk. In the scenario above the amount put at risk is 20% of the initial capital.

Now let us assume that you make 6 consecutive bets, with 2 winning trades of +50% and 4 losing trades of - 20%. This is in line with the expected returns. If your initial capital was $ 100.000, your account will show

Would you really call this a free lunch? It is one of the safest methods to go deplete your account. After 50 trades you will have lost half your capital, which is the widely accepted equivalent to ruin.

This is not a theoretical case. The above approach describes the problem of leveraged exchange traded funds. As an example let us assume that you had invested $ 100,000 on January 1st, half of the amount in the ProShares Ultra S&P 500 (2x long, symbol SSO) and half of the amount in the ProShares UltraShort S&P 500 (2x short, symbol SDS).

SSO: Open 2008/01/01 83.70 -> Close 2013/ 02/20 67.79
SDS: Open 2008/01/01 185.77 -> Close 2013/02/20 47.75

After 5 years your initial stake would have decreased from $ 100,000 to $ 53,347, which is close to ruin. This shows the detrimental impact of volatility on returns, which is reinforced by the daily rebalancing of the funds. You don't have a risk neutral investment, if you put half of your money in a leveraged long ETF and the other half in a leveraged short ETF.

I think that understanding risk has more to do with mathematics than with psychology.

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The following 5 users say Thank You to Fat Tails for this post:

From how you framed your question, I understood that you were saying I had set aside some capital for this strategy alone (see my reply to @ratfink):

...which is free-lunch, and I modeled exactly this in the Monte Carlo simulations above and it is very clear that your capital doesn't fall anywhere near -20% in 1000 consecutive bets with >99.9% confidence. I think the problem that lies with your response is that you are assuming 100% of your entire account capital is placed on each trade, which is not in the spirit of:

If you place 100% of your entire account capital on each trade, even if it is in treasuries buy-and-hold (not some leveraged ETF), there is no realistic situation under which you can avoid sizeable risk of insolvency, so good luck.

The following 2 users say Thank You to artemiso for this post:

I think the most successful traders are able to balance their risk appetite with risk aversion.
Being a risk taker does not automatically make you a leader. It could make you a fool. Lots of leaders remain in the background, calculating their next move. They know when to press
and put on that risk and they know when to pull back and observe. It's a delicate dance that is mastered
through lots of thought and preparation.

Strategy ≥ Money

The following 2 users say Thank You to Massive l for this post: