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I think the whole 1%, 2% thing is what you tell newbie traders, who don't know what they are doing, in order to prevent them from blowing their account in 3 days. If you are a seasoned trader and you are using a percentage like that, you should be able to tell me exactly the reason why you chose that number, and provide some data and/or analysis supporting that reasoning, no matter what that percentage number happens to be.
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Broker: Advantage, Trading Technologies, OptionsCity, IQ Feed
Trading: CL, NG
Posts: 1,038 since Jul 2010
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Interesting discussion here. I look at risk in three ways as they affect position sizing. First and foremost is risk of loss of capital. When defining this particular area, I look to only risk a small percentage of my trading capital but my "Uncle" point isn't necessarily a static tick amount. It's rather a place that negates my trade idea. So, if the day is extremely volatile and the area that would negate my trade is 30+ ticks away, I would then adjust my position size accordingly to handle that risk level. I think it's silly to trade the exact same position size on every trade with an exact stop amount. By doing so, you're stacking the odds against you!
The second important risk to consider is opportunity loss. This again ties into capital loss and position sizing as this will have an influence on opportunity. An example would be, you think the market will go down and you establish a short entry from whatever your set up criteria is. You get in, set your stop and your target(s). This is where the mistake can come into play. Let's say instead of determining a correct area/level to place your stop, you just throw in a 1 point stop or whatever. The reason for that particular stop you set is that is the maximum amount of money you can feasibly lose without inflicting too much damage to your account. The market then goes up another point, hits your stop and then continues in the direction you expected hitting the precise areas you had targeted. That's opportunity lost from unreasonable stop expectations. This is probably one of the biggest reasons traders cannot seem to get consistent. Had you simply placed your stop at the appropriate area/level, the trade would've worked out perfectly. If you're trading a market that is too big for you, stop! Look for something that is sensible to your account size and risk tolerance. There are plenty of alternative markets out there that provide excellent opportunities.
The third area of risk is I firmly believe that you should trade at a minimum, 2 contracts per trade. Reason being is this allows you to play a little defense while taking profit. Trading with only one contract is another case of having your back against the wall. By scaling out as your trade moves in your favor, you're guaranteeing a break even or profitable trade provided you set your initial scale out appropriately. So what's an appropriate initial scale out area? It needs to be one that allows your trade to be break even or slightly profitable. The more contracts you trade the more creative you can get. One mistake I've seen is traders trading say, 2 contracts. First scale out is 2 ticks while their stop is 6 ticks. How does that make sense? Guess what happens? They get their initial target hit and then the market takes out their stop resulting in a net loss. If trading 2 cars, place your first target equal to your stop and let the other one ride or go to a target that makes your R:R favorably positive. Also, when I say break even, I'm not saying move your stop to your entry area. That's another inexperienced move to do. Markets will often return to your entry area which is where people get taken out and they end up losing on opportunity because the move works out as they expected. You can of course begin to trail your stop once the market has moved in your favor by a certain amount but you have to give a trade time to develop and moving a stop to entry too soon can take you out of a nice trade.
I know there are always the guys that say all in, all out is mathematically superior, and if that is what drives them to be good traders then hats off. For me I am more keen to play to my psyche and taking off risk along the way in a trade, scaling out, taking profits, it all works better for me.
I also scale in. For the longest time, I was afraid to do this because I misunderstood the message that is hammered home "do not add to losers". I started by only adding to trades when they had moved in my direction. But now I add to trades that both move in my direction, as well as move against me. However, there is an incredibly important distinction that you must make ---- has the trade moved against you, but is still valid? Or has the trade moved against you, and not your original trade idea is no longer a good one.
Clearly you shouldn't add in the second scenario when the trade is no longer a good trade. And that is where most people go wrong, they average down/dollar cost average to try to minimize pain. For me, I simply know ahead of time that I will likely add once, twice, maybe even three times in a trade, so I never put the full trade on in one spot.
But I also trade much bigger charts than I used to, and bigger charts than a lot of people on the forum these days. That is important because my stops are much bigger, as are my targets. Again, not talking about $$$. I am talking about distance in ticks, not dollars in ticks. I sometimes trade using my spot forex account and sometimes full sized futures, all depending on what the total trades I have working in the market are doing and how much my risk exposure is.
I wanted to make a point about risk outside the mathematical analysis of it - I digress for a bit then bring my subject back to risk towards the end of this post...
Something that strikes me while I'm reading the posts in this thread is that it seems many here feel what they are doing when they trade is somehow different than what the "big money" of "big players" are doing. This is a viewpoint I've seen expressed elsewhere on this forum as well. I'll try to explain what I mean. It seems that many feel that they are playing in a different game or with different rules because they are trading small size (in a relative sense, if you are trading intraday on the ES, many would consider anything smaller than 10-20 contracts to be "small"). I get the feeling that many also feel that because of the methodology they use that they are playing a different game than the "big boys". I'm not sure if I'm explaining this adequately but perhaps the counterpoint will illuminate.
When you place a trade in a chicago or NY futures market, you are stepping into the ring with the heavyweights - this playing field is level. You and "them" are all clearing your orders on the same exchange and the mechanisms that lead to order fills are the same in both cases (yes, big money may have faster computing power than you but this is immaterial to the fact that all trades are getting matched on the same exchange). You are not "playing a different game" and you are not subject to different rules than the biggest traders in the world. They don't treat your order any different than every other order on the book (excepting, e.g., rules governing large block trades matched via the POSIT system).
Consider this - let's say you trade ES and you placed a trade this morning that generated a 12-tick profit. Let's say you used 2 contracts and were AIAO for $300 profit. Another trader at goldman sachs places the same trade with 500 contracts. She made $75,000. Within the limits of the liquidity of the market you're trading, there is NO DIFFERENCE between what you are doing and what the GS trader is doing. There is no difference between the mechanics of their trade and yours - the CME matched your order with orders on the books just the same as the GS trader's order (of course the GS trader's order had to be matched with more orders...).
My point being that when you trade, you are competing with and playing the same game as EVERYONE ELSE. If you are able to take money from the market, you are beating most of the traders in the game - you're not "taking money from the bottom 25%" or "taking money from other rookies". If you are consistently taking money out of the market, you have achieved a skill-level such that you are right there with an elite group of competitive traders. You are tow-to-tow with the "big boys" and winning. Do not make the mistaken assumption that you can be "OK" at trading and make money consistently. Do not make the mistake that you only need to beat some other beginning traders to start making money.
In this sense, what you are "risking" when you engage in trading is that you are not skilled enough to WIN - that you (or your methodology) are not good enough to take money OUT of the market. If you are not good enough to win, it does not matter how much you risk on a given trade - this simply determines how slowly or quickly you lose all your money. I would offer the assertion that if you are not, at least in part, thinking about risk in this way - you are not "good enough" to take money from the market and by managing your risk profile you are simply modulating the rate at which you lose your money.
George Soros said "It's not whether you're right or wrong that's important, but how much money you make when you're right and how much you lose when you're wrong." He was one to press his bets - he bet huge when he thought he had the edge. My point being you're not going to bring down the Bank of England using a mechanical approach to risk. Obviously you don't have to be George Soros to make money consistently, but if you think you're not competing against the likes of him, I would say that you're wrong.
Seek freedom and become captive of your desires. Seek discipline and find your liberty. - Frank Herbert
You are both driving on the same Interstate highway, but one of you is driving a Pinto, and the other a 18-wheeler weighing 40 tons. You might be on the same road with the same exits or red lights, but the playing field is hardly level. For proof, simply drive your Pinto straight into the 18-wheeler and see if he even notices or if he just thinks a bug hit the windshield.
I will give you that trading with large size can allow a trader to manipulate the market to a degree - a very large trader can choose to defend a price level or push a market through a price level. However, in the ES this would be very costly due to arbitrage and liquidity - as it would be in any major currency market. In some smaller markets, a large trader can manipulate a market more easily - but the risk:reward is less favorable due to the overall size of the market. Beyond this type of activity, the playing field is level - if you can provide an example that counters this statement, I would like to know about it.
Seek freedom and become captive of your desires. Seek discipline and find your liberty. - Frank Herbert
Magnificent point. Context is everything. There is even a point of view that every trade one takes...no matter what kind of trade, or context or strategy or entry exit point or risk tolerance.........has a probablity of 50/50. This is arguable...highly arguable. That means there is no diffrence between a monkey and a risk cognizant trader....and while that makes good copy here I doubt it would stand up to scrutiny.
I have seen enough good discretionary traders that make Mike's point so potently valid and the 50/50 probability point invalid (with context). Understanding when to apply what, how to trade a range day versus a trend day vs a reversal day, context of news, of truly contrarian thought, of levering up when things literally fall into your lap and mostly to simply not commit any money to the market at other times is a life long learning process.....
Mike, could you give an example of such a trade where price has moved against you while still considering your original premise valid? I'd be interested to see such a trade on your bigger chart interval that you currently use.
If i consider my own experience specially on the ES where price can go up and down the same distance during the day session i must admit i would not know how to deal with that effectively psychologically speaking. What rules of thumb or recommendation can you share to help in that department.
Also, how can you effectively manage such a trade if you trade during regular hours ? I typically trade the regular session from 8:30 AM to 4:00 PM EST. I don't trade during the night. I am trying to determine if i can increase my interval but not at the expense of my life.