In my view, trading is 95% psychological... for those of us who don't like to be wrong as often as we are right, 3:1 may not be psychologically possible... A lower expectancy achieved with 1:1 and 80% hit rate for people who "need to be right" may be the way to go, rather than a higher expectancy 3:1 and 50% hi rate... Having said this, 3:1 is a sound approach, but only if you are psychologically prepared for the win rate% implication and can consistently deal with it over the long run... Fwiw, excellent post acrary (as usual)...
No insult taken. Another problem is, I only trade the first 1-1.5 hrs of market open so I can not hold my trades as long as I'd like to. When it's time for me to leave for work, I go flat regardless of where my position is. My current platform does not support OCO orders so I can't just enter a stop and a target and leave my PC. -Fast
To trade with an arithmetic expectation as discussed, trailing stops are essential. Letting a decent winning trade turn into a losing trade is, IMO, the single biggest error inexperienced traders make. Of course trailing stops lower the percentage of "full target" winners realized. So while shooting for a 3:1 w/l ratio in units as expressed in points made or lost, it is, (in terms of a simplified "system" of target trading) just good risk and money management to start a trail at a one unit profit. This makes a w/l rate on all trades of 50% at least potentially, if not most likely profitable. Which is really the whole idea of trading. Expecting to have more winning trades than losing trades is a completely different thing, and far more difficult for any trader. But particularly so for less experienced traders. Far far more difficult. Peace, RS
I created a simple excel spreadsheet that will show all the different net profit results from this type of money mgmt strategy outlined above. The spreadsheet shows 4 different winning %'s from the spreadsheet you can see that even with as low as a 20%/80%, win/loss ratio you would at worst be at breakeven after commission. Very interesting results here. Remember this is all based upon 5 ES contracts, 30 trading opportunites on a monthly cycle. Results are gross and net for a months time. Here is the attached spreadsheet. Enjoy.
Just curiously: Should we trade comfortably with a (historically) profitable, reliable and consistent system of winning (say) 65% accuracy and wins lesser than 3 times (say 1.5 times) the size of losses, as the ratio might be probably (who knows?) the best possible returns that would be allowed from a particular market? If yes, then why 3:1? BTW: When some would suggest even not to guess the market's directions with high certainty, how could we newbies (without much foresight capability Yet) be able to measure, whether precisely or approximately, the ratio of a potential trade before placing a particular order? Any pointers of books/sites for reference?
honestly speaking i never tried strategies of the mentioned. having said that i am eager to learn more on money management. thus i am interested in this discussion. my principle reluctance on the subject is based on the thinking that the market will not behave differently just because my pnl has changed. my stops and the number of contracts must reflect my current risk appetite. i understand that first you have to define the amount you are willing to risk as a percentage of your capital, then you place your stop according to the current market (maybe volatility dependent), then you can calculate the number of contracts you want to trade. now, i am reluctant to understand why i should do something just because my pnl has changed. when i add to a position it is simply another trade, independent from the first. when i reduce a position it is the same - just another trade. but i must not see these as bound together, because they must reflect my opinion on the market and the market does not know my pnl. i think it is possible that concepts of pyramiding or deleveraging can work while they shed illusory light on the circumstances. eagerly awaiting your correction of my mistakes in thinking ...
Putting on a position of 10 contracts with a stop of 10 points means a possible loss of 100 ES points or $5000. In Acrary's example this loser is followed by a winner that brings in 10 X 30 points or $15,000. Net profit of $10,000 sounds great. Problem is that winners and losers do not have to be distributed that way. What if you have a series of 10 losers in a row? Now you have lost $50,000. So in addition to looking at risk/reward ratio, the trader has to look at how much total portfolio "heat" he/she can tolerate. Position size of 10 cars would be appropriate for an account of x dollars depending on how many consecutive losers you hit before you start to see winners. In other words, you have to use a Monte Carlo engine to see how it plays out. This is exactly the reason undercapitalized traders get washed out of the game. There are only three ways to handle this, either scale down the position, scale down the stop, or don't trade that market. If you scale down the stop, you may get washed out because you are trading a noisy market (like the ES). So finally we get to a bottom line, which is this: you have to know how noisy your market is to determine the stop. The stop determines the position size and then the position size determines the account size. One opinion. Steve46
If you accept 3:1 as valid , it will inevitably leads you to a higher timeframes then those you are using now ( 5 min or less ? )to generate entry signals . You will need more capital and much more discipline to trade 15 or 30 min then 1 min, however that is the right way to do that . Walter
Exactly very true Walther. Scalpers dont worry as much about making 3:1 on their money. They were about frequency which will offset the mitigating results of a lower reward risk ratio such as what a scalper might be used to such as 1.4/1 or something like that. Higher reward/risk ratios should be saved for higher time frames. Higher time frame strategies will always require more money because of increased holding period times. Increased holding period times mean slower trading. Etc Etc. By the way folks did u all get a chance to look over the Excel spreadsheet and that money mgmt idea. I am waiting for some feedback on it from you guys. Do you see it as good, bad or ugly?
IMHO opinion every investment which does not provide risk free rate of return will go bust in the end. no matter how unlikely a streak of losses will be, once it will occur, it is just a question of time until such a streak rbings the account below the fixed cost for one contract and thus whipe it out. now, for stable strategies this probability of bankrupcty might have its mean in five hundred years. depending on how aggressive you are playing your strategy you will end up somewhere between now and infinity with your mean probability of bankruptcy. you can freely choose where you want to position yourself within the limitations of your strategy. it is obvious that some futures traders who accept 30% draw downs twice a year will have a shorter expected life time than intraday traders who never loose more than 5%. i think there is no real "answer" to your question, steve. i've seen quite a number of traders who did great figures year after year and suddenly went belly up. IMO they violated rule number one in any game: make sure that you stay at the table. or within the above line of argument: their probable period until default was too short.