Is the current Trade Planning and Trade Management a farce?

I tried to make Kelly math work for me about 8 years ago, I think, but it failed with trading my automated strategy that uses reversals. At the time I thought Kelly math would be excellent method for position sizing. If you can find a way to make Kelly’s math work in your actual business model for trading than do it – more power to you.

The question I have asked at conferences for years is – show me a real live example of Kelly math working with an edge or strategy, not a text book example, of how it controls risk. I would love to hear one. But no one has ever stepped forward.

You are absolutely on the right track in your trade management thought process. The most important part of the trade management process is to test these methods and see if they produce the results you are after. If testing shows positive results than paper trade it to verify the results. Then live trade it and further tweak it every performance period until you get consistent results. Then tell us all about it. Good luck.

 

Please, please Rabbitone, before you burn the books try to read and understand what the authors say. Most say "don't risk MORE than 2% of your capital on any one trade". Do you understand the difference between no more and exactly 2%?

I quote Willian Eng, page 3 of his book Trading Rules:

...the maximum that I feel confortable risking is no more than 2.5 percent of my total capital on any one position

Pay attention to the words: Maximum, no more, feel confortable...

There is no 2% rule, it's only in your mind.

Now, it is up to you to try to read the books carefully or go ahead and burn them. I doubt though that you have read any book at all carefully enough.

 

I could care less what is in print or if some author “may” have had presented “my” alternative in literature. If you read what I wrote that is not my point. What is in print today are theories and nothing more. Most of these authors, in the past, have never presented one real trading example that has made money consistently using these methods.

That is starting to change. Traders are feed up with non working examples. A few authors ,like McDowell and his “Art of trading”, are presenting a working business model along with their edge. That is why his method is so popular among “newbie traders”.

Your right you have not seen how my alternative method is completely different. I can’t get a word in edge wise from the cat calls and hecklers that get their thrills from destroying a forum’s progress before a process is even completely presented on ET. I did present a summary but I have had a chance to discuss the details.

 

I’m not an academic like I was in my youth. I have a trading business to run. Statements like “Most say "don't risk MORE than 2% of your capital on any one trade” tells me and you nothing about how to build real trade management. I need to arrive at a real number in trading my edge that protects my actual account balance. That is what I have been talking about.

I could care less if its 1%, 2% or 3% that was just an example. My point is 2% is used as a benchmark in website after website . Some poor schmuck is going to lose his account in trading because he can’t figure out what real risks are produced from the edge they built. In desperation they will use this 2% for lack of an alternative with their edge and lose their account because they do not know how to get to the real risks their strategy produces.

If 2% works for you great! But for many its a disaster.

 

Well, maybe you should tell us then specifically how one can determine the optimum risk percent given a trading system. All you have done up to now is flaming authors and threatening to burn books but I have not seen a formula.

I have a system right here and now, and I am asking Rabbitone who is refutting everything we know how to determine the optimum risk.

Please hurry up because I must trade soon.

 

How many times do I have to say it.. With my method:

There is no formula for position size. There is no formula for position size. There is no formula for position size. There is no formula for position size.

What you have to do as trader is dig the correct position sizing out of your edge or strategy by testing, paper trading and live trading to get to the risk YOU can handle as part of YOUR trading. The strategy YOU develop requires a position size YOU can live with. I am never going to tell YOU what risks to take on.

But these authors and websites have no shame. Many are out there waving the position sizing flag and telling traders how much to risk. Millions are lost every day because traders have not developed a risk profile of their edge or strategy. Most authors don't even touch that subject of determining a strategies risk profile.

If you don’t know what risks your edge or system produces. Nothing can be done. It is your business and your losses. Only you can determine a reasonable position size through hard work.

My objective is still the same to determine with my strategies:
What is the maximum rate (or amount) of funds loss that I am willing to accept during a performance period and cumulatively from other performance periods. This is what will drive my position sizing.

 

So according to you, the position size is determined by testing, paper trading and live trading.

Hmmm...but isn't the case that paper trading or live trading require that you take a position to start with? Especially in the case of live trading, what should be the position risk in the process of determing position risk?

I think your argument is circular.

 

When you test an edge or strategy it will show you where they risks are. Do you know how to identify them? That is the lost important part. By the time you live trade the position size is for the most part determined. Only if risks show up in live trading that were not found in testing only then do you make changes to position sizing. There is nothing circular.

 

Let us start with some simple examples.

The first object of the trader is set up is a basic business model. This will answer what kind of risks you are willing to take on with your edge. These kinds of models start out simple and grow. Let’s start with some simple rules:
1. You set a max drawdown of 6% in any month in any one performance period. When and if this is hit you will stop trading for the rest of the month and think about why this limit was hit.
2. The next rule is specific to the swing trading strategy. In preliminary tests I had 8 trades a month. From this I decide the performance period is 4 trades or twice a month. In the 12 months of testing you had 3 drawdowns one had 4 trades, one had 3 trades and there was one with 2 trades. You are a new trader but decide the maximum risk you feel comfortable with is handling a 4 trade drawdown in one performance period.
3. Combing the 6% max and the 4 trade drawdown gives a position size of 1 ½%

Your own money management rules are built by working in reverse. When you look at the swing trading system it trades 4 trades a performance period. That means the most you can take on in is a position size per trade of 1.5%.

Then you run this through paper trading. You find average loses are 1.8% because volatility is higher. So the position size is kicked lower to 1.18% to compensate for the volatility. This is the kind tweaking process you build to get the system in line before live trading. If it does not match at the first performance review in live trading it gets tweaked again until you get it right. It is lots of work

 

Now let us discuss some other trade management scenarios. This one will be a programmed trading solution.

One of the toughest problems in overcome in trade management is what I call the PRICE BAR TRAP. A good example of this happened to me a few years back at a conference. I was talking with a new trader who was at the conference trying to fix his automated system. The system worked great in testing, but gave him all sorts of different results in live trading (that is many large losses).

I asked the trader how he would program a 1-2-3 bottom reversal (see attached) we had seen in the session. He said his stop would be the distance between the 2 lines on the attached chart. He used a fixed fractional position size to calculate the number of shares to trade. When the trader told me how he would have programmed the 1-2-3 bottom reversal solution I understood what the problem was.

What the trader had failed to take into account was the affect that volatility would have on the price bars and the calculated stop on this trade set up. His programmed solution was dependent of the size of the price bars from testing to build his stops. What he failed to take in to account is the distance between those 2 lines can grow too large for the number of shares being traded and create losses that are much larger than anticipated.

One method to handle this problem is to track the programmed solution using Average True Range (ATR) to build a position size. If the volatility rises when you start live trading in a performance period than the position size can be reduced by a ratio of the tested ATR to the current ATR. When and if the current ATR jumps higher than the original ATR amount than the trader can make the decision to pull the plug or continue trading.

Another solution to this problem can be done in the trading program. This one is harder to do. Using the 1-2-3 bottom as an example the trader would have to define programmatically what a “typical stop” looks like. When volatility jumps higher the trader would than reduce the position size for that trade.

Which ever method is used the trader can then take these expectations and methods and write them into their business method in their trading plan. Then the important area is to verify during a performance period of live trading that these result are in line with expectations. If they are not in line then either the strategy is tweaked or the programming process is modified and we re-test.