As far as increasing position size based on loss, that was my idea not the OP's. In terms of the method of increasing risk based on volatility/stop, I don't think it gives me a particular increase in my edge, as you have to work with such small amounts, you're better off just having a system (as illiquid is describing) with a pretty good positive expectancy and good basic position sizing ... and well, trade it. Ciao, Jimmy Jam
Increasing risk after a loss would make sense to me in a game such as blackjack, where presumably if a greater number of "negative-count" cards have been dealt so far, the player would have probably experienced a "drawdown" in equity for that part of the shoe; however, this now leaves the rest of the shoe rich in "positive-count" cards aka 10's, which is favorable to the player and would require him to raise his bets. In trading, I don't find a logical connection such as the above in raising one's "bets", whether via size or wider risk parameters, based on previous losses. I could see the reasoning for possibly reducing one's size after a series of gains for a certain type of trading -- however, in this case the reverse situation of increasing risk after losses would not apply either.
Risk Management makes the difference. I can recommend reading "Trading Risk" by Kenneth L. Grant as an introduction. He emphasizes one important principle (in order to preserve yours ;-): Take more risk when you are up and less when you are down. Losing and adding risk is similar to averaging down. You can do it, but in the end it destroys with a high probability (perhaps after you got rich, but so what, it means only falling deeper.)
Ah ok. No, don't worry, I was definitely not going there. Not looking for any tricks Yes, of course entries are important, but unfortunately, obtaining a good entry envolves alot of "luck" (for lack of a better word off the top of my head) inso far that whater formation or set up you see, the market can pull a fast one, and we will only realy know if we had a good entry after the fact. However good one is at getting good entries, managing risk involves les "talent" and can be sumed up in a mathematical formula that any idiot can use to enhance performance.
Jimmy, again, the size of the trade is NOT necessarily tiny. Taking on small risk does not necesarily imply a small position. For example, my positions tend to be rather large in low volatility zones. This is because the low volatility allows for a tighter stop, and to off-set the tight stop in order to maintain my desired risk, size is proportionaly increased (vice versa in high volatility zones).
<i>"seems to me you are only considering 1 sequence of trades here. if you do a monte-carlo analysis of many sequences of trades, then the drag is not there. the compunding effect of consecutive winners negates the drag."</i> <b>M4</b> is dead-on correct... I've run enough Monte Carlo simulations on a vast array of systems to know that fixed % risk of capital on each trade, greater size into runups and lesser size into drawdowns accelerates the equity curve greater than all else WITH smallest degree of ruin risked. (wow, what a run-on sentence there!) If any trader keeps adding size to trades as a loss streak extends to play "catchup", they run the actual, real risk of reverse-leveraging their way to a blown-out account. Think it cannot happen? Heck, I've done exactly that too many times in the past myself! Stick with that tactic long enough, and a big blowout is not only probable, it is ascertained in time.
Illiquid, To borrow your blackjack example, lets look at this. If go to the table with 10 000, bet 1 000, and lose, and then if you bet 1 000 a second time, you have in fact just increased real risk because by betting 1K on you remaining 9K is risking a larger % of your capital (1K of 10K = 10%, and 1K of 9K = 11%). In regards to the cards being dealt, I presume that you are saying that the odds of winning can be increased once the poor cards are out of the game. A similar idea can in fact be applied to the market. For example, every move higher in the market takes price all that much closer to a correction/reversal point. Ok, before I get stoned now, of course the big difference is that a deck of cards is finite and the number of cards know in advance whereas the market can trend against you for an unknown distance. In consideration of this latter point, we can thus conclude that whatever trading/management style one uses, the market can hand out a long losing streak and eventualy blow you up. A long losing streak is not just some theoretical possibility that might happen, it WILL happen sooner or latter in one's trading career. Well that is precisely why I have put so much time and energy into risk management and have come to the conclusion that increasing risk after a loss is the better bet. Furthermore, as you may have picked up on this during this thread, my management style is not simply a mathematical formula that disregards the market. It is greatly based on the volatility that the market exhibits as my position size (not necessarily risk) tends to increase in low volatility zones, and decrease in high volatility zones. One observable fact that supports this aproach is the fact that volatility can only decrease so much (in theory, volatility can decrease down to the size of the bid/ask spread), whereas volatility can increase infinitely. What would happen if one were to DECREASE risk after a loss? Well, after a relatively long losing streak, the risk taken on might get so low that just making it back up to highwatermark (break even) may become a titanic feat, may take a very long time, and may even become highly improbable.
How can you justify taking more risk when you are up and vice versa ? As far as taking more risk when you are down is concerned, look back through the thread for justifications. Is it possible you are missing some important points here ? I am definitely not suggesting "adding to losers".
Your statement would be correct if the risk increase after a loss were to be "rather large". This is why it is important to control risk increase rate to a safe level. Again, any method can blow an account with a long enough losing streak. Furthermore, in regards to increasing size after a loss is concerned, your acertation is incomplete. As I have mentioned many times here already, you can actualy increase size while decreasing risk... its just a question of running a tighter stop and in low volatility conditions this can be entirely justified. Size is not the only risk perameter. There is also stop distance. these two can be combined in a manner to reduce risk while increasing size. Vice versa, risk can be increased while reducing size if the stop is just placed further out.
If my equity is up I should use more of it. Example: I risk 1% per trade of my equity on 100.000, which means 1000 per trade. So when I am up 10% I should use 1100 per trade. Same vice versa (then it is more about preserving my equity). You are right. Adding to a loser is different but I think you can compare it to taking more risk when you are loosing because both can very fast harm your equity (and without it no trading )