Defining Risk

Discussion in 'Trading' started by rtharp, Jun 9, 2001.

  1. HI I'm starting a new thread as the Great New Pattern Thread is getting off topic.

    I just spoke for DaytradersUSA and my main topic I tried to cover was Risk.

    This is one of the only things you can control as a trader.

    Risk is where your stop is. It's also multiplied by the # of shares you own.

    Here are some examples for a $100,000 with different stops.

    easy #'s for easy math.

    Stock Price =100
    Risk for this trader is 1% of $100,000 = $1000

    XYZ is entered at 100. The trader is a daytrader and uses a stop of .10 (yes I know he's probably going to get some slippage.
    To have a risk of $1000 he needs to buy a lot of shares with a .10 stop.

    (100-99.9) * 10,000 = $1000 He would have to buy $10,000 shares to have a risk of $1000

    (this is why I was so interested in professional leverage he needs to have $1,000,000 available for this amount of shares)

    A .50 stop would mean he needs to have 2000 shares.
    100-99.50)*2000=1000. This is what a normal trader can do with a retail account and having his account fully margined.

    a 1.00 stop means he would need to own 1000 shares.

    (100-99)*1000 =1000

    a 5 dollar stop would mean only 200 shares.

    (100-95)*200 = 1000

    a 10 dollar stop would mean he could only buy 100 shares

    This is your risk per trade. Multiple trades are your portfolio heat. It is understanding of these concepts and so many differnt money management strategies that allow me to produce triple digits returns every year.

    This is what "TRADE YOUR WAY TO FINANCIAL FREEDOM" by Van Tharp covers in depth. Take a look at the reviews here on this website if you are curious about it. is how to reach Dr. Tharp.

    Now on the Great New Pattern Thread I'm not sure how much Risk Pre2 has on ELY. 19,000 shares sounds like a lot. but where is his stop? and what is that in relation to his account?

    Now someone else asked about me losing 1R but when I'm right I make 25R. Yep that's just about it. When I have a winning trade it's absolutely huge, when I'm wrong I cut my losses short and find another high probability setup.

  2. orginally posted by Mgregor on Great New Pattern Thread


    Thanks for your reply.

    I'm still quite perplexed by praetorian2's 19,000 share position in ELY.

    I just can't imagine taking that kind of risk on one trade. It kind of reminds me of Jesse Livermore. I guess that's how great fortunes are made... and LOST!

    Well first Did you read my review of Reminiscences of a Stock Operator here on this message board? I think very little of a trader who continually wipes out. He was a gambler and didn't understand position sizing.

    Praetorian2 does cut his losses. He got out of PTA when it went against him. The question is/was is he risking the optimial amount to trade for a long time. From what I've read he may eventually have a trade go heavily against him which could give him a serious drawdown that might take years to recover. He might also have another 300 great trades and have an absolutely huge account size so that he is automatically forced to start to keep his risk in control by trading illiquid shares. I'll trade the long side of somethng heavily oversold but I tend to give them less risk per position. This is due to the downside being twice as fast as the upside. If I'm wrong on something that has already broken support it might have even more to go, with size this can hurt as it's very hard to exit a position in a freefall.

    The opposite pattern I'm playing of heavily overbought is a lot easier for me. This is because I can easily buy if the market is in a rally on a heavily overbought issue to cover a losing short. Traders are greedy in their nature is to cut profits short and let losers run. Meanwhile when I'm right on the downside it falls so hard everyone is climbing over each other trying to get out. I feel a lot safer having a bigger position size and a very tight stop on my shorts.

    This was one of the reasons I started to want professional margin so much. I understand risk better than the average trader and additional leverage means additional profits to me without adding much in additional risk.

  3. Jeffrey


    A system that produced nine losers for every winner is very common, right? Let's assume that we're dealing with typical traders thought process. Well then, being a successful is very easy. You know you have consistency (not random-50/50), so simply sell when you would normally buy on emotional enthusiasm, and cover the position when you would normally panic sell.

    The concept is very easy to understand. Why can't traders do this? Psychology.(Trading on emotional feelings cloud reality) A technical set of rules is needed.

    High probability trading is found by your own commitment, time, study, and experience. I use a high probability trading system to trade successfully, and I know that 90% of the traders, who use it, are not successful. This is reality for any system, and most any activity.

    For a beginner trader, write down a trading(training) plan, and objectively measure your progress. Most don’t have the discipline.

    First know your trading system and rules like the back of your hand(memorize). You need to learn to react, not think. Use at least 3 to 1 Risk/Reward ratio.

    Then, find consistency(Percentage your rewarded) through paper trading before moving onto the next step in the plan.
    Starting with real money, and then use small share size. In this step you can expect your consistency to drop some, while perfecting your order execution skills. You should gain your consistency, and let your trading account build to the point where you can move the next step. Increasing share size.

    Rocket Science: I think most traders think to much. Understand that this is not easy at all. It takes commitment, and patience. After you start trading with consistency, you will then see how simple trading really is.

    Regarding Risk: Rtharp explained himself earlier. From my point of view, I will enter intra-day, and decide just before EOD if the market(s) conditions, and/or profit cushion, warrant holding overnight. Leverage will enable a trader with "Objectively Measured" consistency, along with high probability trading, to gain multiple profits.(percentage gain). I would concentrate on the trading plan one step at a time.

    I believe greatest risk is with the beginner traders who do not know, or have the discipline to follow a plan. This is why I am against any marketing B.S.. Rarely do I hear the importance of a plan, emphasizing health/safety. If potential traders ever heard the truth about the odds of making it in the stock market, or the neccessary time and effort required, a large percentage of them would not buy what is being sold.

    There is no place for levity in the stock market. Analogize the stock market game with any high-risk activity. Does a stuntman ever think about health, and safety? Accidents come from neglecting health and safety. Stock market trading is as individual sport that I consider a high risk activity requiring quick timing such as Mountain climbing, catching a wave(surfing), Kayaking, Swimming, Springboard diving, Skateboarding, BMX bikes, Skiing, Snow boarding, Hang gliding, Mountain biking, Motorcycling, etc. These sports require quick reactions to current conditions, and unforeseen circumstances. As with kayaking, you’re going to get wet. Risk management will enable you to get your head above water


  4. tradeRX


    Three things....

    If you have a true well-defined system, then ANY trader should be able to reproduce your winning results trading your system. If they can't, they are not really trading your system, are they?

    Furthermore, you should be able to automate any well-defined system to trade independent of you. Can you conceive of a way to do this? If you can't then do you truly understand your system? And if you don't truly understand your system, how can you rely on it?

    Finally, you should be rich in a short period of time with such a system as all you need to do is trade often and scale up the size of your trades.

  5. Jeffrey


    1. We all know the rules of Pro basketball. ANY basketball player can not reproduce the skills, and experience, of a Pro, and one team player can't reproduce the same results as another team player. The Lakers all play by the same rules, yet why do some sit on the bench?(Still successful)

    2. Yes, computer buy/sell programs do this. Individually, a trader can understand a system and papertrade successfully, yet can't pull the trigger when it comes to real money, or when they do, they break the rules. They may make it to a certain step(share size), and stop because it fits their personality, they are content, they consider it as a hobby, or they give up. With the potential to become a very good teacher.

    3. Get all thoughts out of your head about, "rich in a short period of time". Concentrate on playing a game to accumulate the most amount of points in the shortest period of time. Slowly, grow step by step with your trading plan.

  6. tradeRX


    Clicking a mouse does not require the complex skill set that does basketball. There is no comparison. But, my argument still holds true for basketball, baseball or any complex skill model the players biomechanics and you will produce the same/similar results.

    True "trading" systems can be automated. They have well-defined rules. I think what the vast majority of traders call their "high-probability system" is actually just a set of loosely defined assumptions about the market that they more or less apply. And that they deviate from these vague rules for even less clear reasons (gut feel, etc)

    You also missed my point regarding wealth. I have no visions of getting rich quick. My point is a true high probability system would make one rich in a short period of time. All one needs to do is play the system often, and scale up the size.


  7. Jeffrey



    I use analogies to help grasp a concept.

    I understood your point about getting rich quick, and anwswered from a psychological point of view to keep emotions at bay.(Money is not the top priority driving force.)

    So to answer again. Yes, all one needs to do is to play the system, scale up the share size, and simply click the mouse.

  8. mgregor



    I'm not sure that I agree with your assumption that "true trading systems can be automated".

    In fact, I don't even like the word "system" when it's used in regards to trading. It implies that someone has such great knowledge of the marketplace, that their trading is on complete autopilot.

    I don't believe any individual trader has a successful system that is completely automated by computers.

    Only very large and extremely well capitalized institutions can afford to have "program trading", which as far as I know, still has some human intervention.

    Instead, I prefer the term "strategy", which implies that a person has a plan (i.e. entry price, stop loss, and profit goal).

    Trading, whether based on fundamentals or technical analysis, tends to be very subjective. You can ask several traders in a room about a particular stock, and most likely you'll get several different opinions on where it's price it headed, and how quickly it will get there.

    Rtharp makes a very good point that risk is the only thing we as traders have control over. So if one makes it a habit to risk $1 for every $3 or more gained, at least some success should follow.

    Obviously, if one uses some form of technical analysis to better pinpoint entry or pivot points, then the probability for successful trading increases.

  9. DJC


    If there were truly a SYSTEM which produced CONSISTANT returns of 50% or more (or any % much above the S&P 500 ROR) does anyone think that it wouldn't be known by everyone by now, not a few with a "secret" system. If there were a system which could be AUTOMATED and produce these kinds of returns we would all be living in some exotic land having our profits direct deposited to our over flowing bank accounts ( and you wouldn't find this system advertised in a trading mag for "one low price", or on any chat boards.) This game has been going on alot longer than any of us have been in it, and none of us are doing things which have not been tried before. All this chasing after the elusive super system or pattern seems to me to be a waist of time.
    If it were truly only a matter of discipline which seperates the winning trader from the majority, wouldn't computer trading be the obvious answer to this problem? Everyone could just follow their system, set their stop losses, and wait for the money to role in. Don't preset stop losses take the discipline out of pulling the trigger and cutting the loss? IMHO "the trend is your friend" is about the most solid advice you can follow along with monitoring risk/reward when entering any trade.

  10. tntneo

    tntneo Moderator

    I think we drifted again from the topic.
    However I'd like to point out that systems exist. Anyone successful in trading as a trading plan. A trading plan IS a system.

    If all your trades are 'gut feeling' trades, OK, you don't use a system, but you probably are out of the game already.

    So, to be successful you need a system. It does not mean there is THE system, the holy grail, the secret to the stock market. There are MANY systems which work, depending on time frame, market, capital etc..

    Sorry to disappoint those who think they can trade because they have a special gift. :)

    And BTW, yes, a trader can fail with a system by refusing to pull the trigger. If a system is going too much against your psychology or your confort zone you will refuse to pull the trigger at some point. And that violates the system.

    Another example : traders trained in trading floors, they learn a system [!!!], that's how the house wants them to trade and they are monitored. Some do follow the rules, some don't. The only difference : psychology. It is the same house, the same equipment, the same stragegy/system. Think about it.

    #10     Jun 10, 2001