And why the other combinations are excluded : "The first trade is a loser and the second a loser" "The first trade is a winner and the second a winner" "The first trade is a loser and the second a winner" And why should the probability being assumed to be 50% ?
I like the idea of utilizing a 3:1 RR plan with using some sort of trailing stop when you really catch a big winner. The question becomes how large of a trailing stop does one use in this situation? I mean you don't want to cash in your winner right at the 3:1 level if it's got more gas in the tank but on the other hand you have to be careful of those nasty reversals... Any thoughts? -Guru
... should be placed where your thesis for entering a trade is wrong. They should preferably be placed at a price (and time of day) not easy for the market to reach. Otherwise your thesis might repeatedly fall victim to random noise, the result of which is you end up being a collector of stop losses. Any formula based risk-reward system is going to have an expectancy of zero before frictions. Money management systems are tools to help you convert the positive expectancy of your trading thesis into real P&L by sticking around long enough for the odds to manifest themselves. But first you have to have the thesis with the positive expectancy - otherwise money management is just a way to slowly enrich your broker as opposed to rapidly enriching your fellow traders.
mind, Cutten, harrytrader, TheStudent, I fully agree with your excellent comments and would have chimed in earlier but for the fact that I have had similar discussions in different threads with acrary, dbphoenix and others. It is a pleasure debating with acrary, a gentleman to the end, whose posts, always illuminative and imaginative, tell me that he has more practical trading knowledge and experience in his little fingernail than I will ever hope to have. dbphoenix, on the other hand, blocks his incoming receptors, employs every conceivable dirty debating trick, including quoting to suit his purposes and, of course, his trademark arrogance, so the best course of action is giving him a wide berth. This does not negate the fact that dbphoenix is a walking repository of trading knowledge, and undoubtedly a far more disciplined trader than I am. So if someone cannot see that conveniently isolating one permutation out of the set of possible ones can lead to false conclusions, or that position management alone is not a factor in attaining an edge, then, to quote dbphoenix, "who cares?"
Harry123, Base on your spread sheet, starting tomorrow, I will do 1 es contract with a 2pts stops and 6pts gain. I think a 1 pt stop will get me stop out too many times. Will let u know the outcome in a week. If I get a 2pts gain, then the stop would be even and will trail the stop up on a scale of 2pts until stop out or the target is reach. Thanks for the spread sheet.
This type of thinking is back to the search for the Grail. Yes Money Management is VERY important but your missing the point and the intelligence of the Market wizards. Here is the point !!!!!!! All trades should be thought out and planned completely. Once thought out, you should ask yourself the question "Does this have a good ratio" and if you want to use 3:1 fine then ONLY take the trades that meet this criteria. It's not about random entries it's about very SELECTIVE entries with specific objectives. Only then can this kind of thinking become a valuable tool. IMHO this is why so many fail at trading, Everybody wants to be in the market all the time.
The bottom line is your edge, ie: win % * average winner - loss % * average loser. You can trade like acrary with small losses and the occassional home run, or you can go for a high winning percentage with a more even distribution in the magnitude of winning and losing trades. I don't think it really matters how you get there, as long as the number is positive. How you trade depends a lot on your philosophy of the markets and your psychology. I would guess that acrary has done a lot of research into methods that profit from fat tails, so he is very confident to trade a method that has a lot of small losses with a few huge profits now and then. I on the other hand love trading against the trend and picking turning points. It probably comes from the first futures market I traded, which was notorious for lurching from one extreme to the other. Combined with my contrarian nature (the crowd is always wrong), I can never get comfortable trading breakouts. I have tried in the past, but it goes against my philosophy and psychological makeup. I also need constant positive feedback, ie better than 50% winning trades. I think Marty Schwartz said that he loves hearing the cash register ring. I feel much more confident having small and steady gains from this style of trading. So I don't think there is a right or wrong way to manage the risk:return equation. My trading style has strengths and weaknesses, so what I try to do is capitalise on its strengths (employing strategies in markets that fit well with my fading style) and minimise the weaknesses as much as possible (never get my tits in the ringer by holding on to losers, recognising when a market is in a strong trend and staying out, etc).
Careful there le140 the spreadsheet is based on a starting reward/risk ratio of 2.5/1 and utilizing 5 ES contracts per trading opportunity. It is not based on a 3:1 reward ratio. It is based on looking for 3.75 ES points on the gain and taking 1.5 ES points on the loss. Not 6 for the gain and 2 for the loss. Furthermore, the spreadsheet is based on a method where you sell 2 ES contracts of the 5 whenever your up 1.5 ES points on the trade and then you automatically move the stop loss to .5 ES points under entry on the remain 3 ES contracts which you let ride to stop or target of 3.75 ES points positive. It seems to me that you may be about to utilize a money mgmt system that is not made for the type of trading your about to attempt. Please look over the posts again and please feel free to PM if you want to ask me any questions privately or else just ask them in this thread I will be around all night. Thanks.
I agree ! I would add that you cannot change your profit factor by playing with R:R ratios If the price goes from 'x' to 'y' for a period of 't' - the "expected" money you can extract from that movement is a constant...
Great post. Obviously the optimal style (in theory) is to play trending/breakout/pyramiding methods in markets displaying those tendencies, and play the fading approach in the more frequent choppy/rangebound markets. Acrary's position-sizing algorithm (used by many good traders) is basically a simple method of ensuring that this is indeed the case. It uses the initial positions as "tests" of the character of the market. If these positions are profitable, this raises the probability that the market is in trending mode. If further adds are profitable, this raises the probability even more. When the probability is higher, obviously you want a large position on to bet on the continuation. In a similar fashion, good fade traders use increasingly large losses to tell them that the market has changed from a fadeable ranging character, into a trending character. All fade traders know when they have to eventually get out on of a nasty loser, on the rare occasions that a true trend continuation is occuring. Once again, they are using the P&L from their positions as a simple method of detecting the character of the market. They key is to be able to distinguish between profits or losses caused by "noise", and profits or losses caused by a change in market character. If you exit due to noise then you lose. If you stay in whilst mistaking changing character for noise, you also lose. For this reason, I think it is better to observe the character of the market directly, rather than via the P&L of "test" positions. When you have positions on, you get psychological distortions, and are taking risk. If you can observe the character of the market equally well or better without these tests, then you avoid the risk and distortion problems, and are more likely to correctly identify noise versus signal. As for biases, personally when I find I have a bias, I prefer to eliminate the bias rather than stick to markets which suit the bias. This is not always easy but is always more profitable. If I think the bias is unsurmountable, then I will follow Zentrader's method of simply avoiding markets where it will impair profitability.