Listening to your risk tolerance

Discussion in 'Trading' started by vanilla2, Dec 7, 2003.

  1. I've been scaling up at fixed dollar increments in the account. Currently this is a linear relationship, but i've been realising a desire to decrease risk over time in an asymptotic fashion if growth continues, which is a common preference. If I had 5 million dollars, I wouldnt trade aggressive margin, I would probably hold mostly treasury bonds. How have you defined this utility curve in the early stages of your account when you wanted to go full steam ahead, but also felt there was more at stake?

    Last week my scaling system gave me the green light to increase size, and it is so far feeling a little hot, especially approaching the holidays, and just above the scaling boundary. On the other hand, there seems to be a pickup in volatility and a likely runup in progress. If you were trading relatively small lots would you adjust your position size based on these conflicting risks and opportunities?

    I have been considering full size shorts and 2/3 size longs into new years. another alternative is to increase my artificial margin requirement, systematically bumping back down to the smaller size. another alternative is to skip holiday longs completely. final alternative is to wing it and go on my feeling at the time of the trade. It's a difficult slope to determine for some reason. Does anybody do the same, and as systematic traders, do you ever adjust size for qualitative reasons like possible terrorism during the holiday season? i feel like i will enjoy christmas and newyears more if i am not long, but i'm also strict with myself about falling behind the system equity curve, and feel like i've seen these high event risk positions pay off large in the past. What are your plans?

    There seems to be irony in the idea that you get to the end point faster by trading less aggressive margin, but i observe this again and again in the guys who've lasted.
  2. You have to ask why you feel the position sizes are "a little hot". Is it a rational fear, caused by the realistion that a possible big drawdown on a bad run or outlier trade would go beyond your risk tolerance, or it is an irrational fear, caused by psychological issue such as not being used to the bigger size, or focusing on dollar amounts rather than % of net worth?

    If it's a rational fear based on a proper assessment of risk, and the realisation that you want to focus a bit more on capital preservation with your larger account size, then you should reduce your size.

    Remember there is no free lunch in the markets. Outliers and bad runs, equating to big drawdowns, ARE out there, and eventually they will get you. Whether you survive the experience with a bit of pain and become a better trader, or get knocked for six and never recover, is entirely down to your defensive risk control, of which position size relative to worst-case volatility is the most important element (more important than stops).

    You can ignore this for a while, and pump out higher returns, and many people do that and have the good fortune not to get hit until they have a bigger account and become more careful. But if you do that, just realise that you are simply exchanging probability of achieving the goal for a reduction in the time taken to get there. You are gambling a very high chance success in the long run, for possible but uncertain success in a shorter period of time. Unless you have a terminal illness with 3 years to live, I would recommend taking the longer but higher probability route.

    As for my personal utility curve, it has always been the same since I started trading full-time. From the outset I aimed to restrict my drawdowns to 10-15%, with a worst-case scenario (e.g. if there is a huge same-way gap across multiple uncorrelated markets) of down 30%. That was the case when I had $15k, and is the case now, and would be if I had $1 billion. I can't say I've ever regretted sticking to those parameters.
  3. my experience has been that the time a trader can remain focused on what they are doing is approx 20 trading days. This is unfortunate because it keeps the trader from reaching that next level of improvment just by the fact that one gets better by doing the same thing over and over. We all want to get rich overnight, and subsequently get quickly bored with making a consistent and seemingly small $ amount each day within safe risk parameters. We all think that we can find that 'bet the ranch' position each month; but that is quite elusive, except in hindsight, and just keeps knocking us ordinary folks back to the starting gates. I have found that if I forget about that one great trade and just take each trade indifferently, a strange thing happens: when I look back 40 trading days I find that instead of making X each day I am now making 2X; and soon thereafter I am up to 3X. However, then the ego comes in and we again think we are geniuses and look for that 'big score; so at this point focus is important in order to get to 4X by just doing the same thing over and over. By the end of the year, the turtle is the hero at the cocktail parties in the most unassuming way; strange isn't it?

    So never step outside your risk parameters if you want to be a 'success' at this game; and you'll never be profiled in Market Wizards either, because those blokes got lucky and hit it big but the other 99.99% blew out, but we never hear about them; human nature equates each Dennis with a million others out there but it just isn't true!
  4. So drop the rabbit and back away slowly, and enjoy the holiday season. :)
  5. You must also have rules that state when you drop back in size, not just when you up it. Heres a little example that is not real world dollars but lets say using futures contracts;
    1 contract = 5000 required equity
    2 contract = 7500 required equity
    drop back to 1 contract at 6250 equity (1/2 way between the increase amount) then go back to 2 at 7500.
  6. Guys, thanks for the fantastic advice and input on my situation that many of us have faced.

    Excellent insight:
    "realise that you are simply exchanging probability of achieving the goal for a reduction in the time taken to get there."

    Cutten, I think you nailed it with your question about rational fear versus psychological issues with size. I would like to believe there is no psychological issue here, and that this is quantitative risk aversion. I took a new look at the stats, and indeed, I am running too hot. I believe I'm risking up to 3.3% max per trade, and the huge same-way 30% gap you mention would clear out my account. I have acknowledged that my current risk tolerance is skewed by my financial needs as a beginning trader, which led to the question, why should I be any less risk averse in year one as I would be in year 20? Dollar for dollar, the risks are different, but in relative terms they are identical in either account size. Conclusion ... time to 'drop the rabbit' as you eloquently put it plumlazy, and cool the jets a little.

    btw - what do you think would have to happen to produce a 30% gap, and would we have bigger problems at that point? I figure this to be roughly 6 consecutive limit down sessions in on the indices. Either way, something is wrong if any one position has the potential to destroy an account under any circumstances. It must get really relaxing when you're well capitalized enough to still make large cash returns trading very low risk.

    Either way, at least for today I had a small down day and am back below my scaling boundary so the heat is temporarily down. I think the best solution is to just raise my artificial margin and trade smaller. skewing longs and shorts gets into a sort of dangerous predictive business imo.

    I really appreciate your input into my process. Happy holidays guys
  7. 9%

  8. funky



    obviously i don't have much experience with this issue yet (you are way ahead of me) but i would say, stick with your thresholds of upping contract sizes. if your account goes back below those thresholds, then reduce size accordingly (like you are doing).

    if the mechanized nature of your system has worked for you, then mechanize the sizing!

    rock on!