Discussion in 'Forex Trading' started by millionaire7, Sep 18, 2009.
what is the meaning of Risk appetite in currencies.
Well, in some ways I think some of these concepts are pretty odd. People usually call it "risk tolerance". I have a video of Jack Schwagger (author of Market Wizards) where he says that he looked at the performance of CTAs (money managers in the futures markets) working for a brokerage firm (may have been more than one, didn't notice). In any case, he said (for reasons he didn't explain) he looked at what customers did in their accounts as well. He said that some people say that they may have a risk tolerance of 40%, but some will sell to cut their losses at 10%. (I'm not sure how he got the 40% figure, maybe the customers answered questionaires about their risk tolerance.)
*(I also find it odd how investors in a managed fund could cut their losses at 10% while beginners who trade for themselves can wait until they have a 50% loss to bail out. Maybe it has to do with having a sense of control over your money when you're trading and having no sense of control when it's managed by someone else.) (Another side note, Nelson Freeburg looked at the 10 best systems that John Hill tested and found that if you invested when a fund peaked, you could have waited a year and a half to get back to a break even level. So, maybe looking at the funds which have done well in the last five years but had a significant drawdown in the last six months would be a better idea than just looking at the fund with the best return last year.)
Anyway, I kind of see risk in Forex like this. Let's suppose you devise a method where you can cut your losses at $30. (You can assume this might be on a mini lot. And a standard lot is 10 times larger than a mini lot so you can multiply the examples here by 10 for figures for standard lots.) And suppose your method makes money even if it OCCASIONALLY runs into 10 consecutive losses in a row. So, if you had $1000, 10 consecutive losses of $30 would be a maximum drawdown of 30%. (That's a $300 loss divided by the total of $1000.) If you had a 50% loss, you'd have to double your money to regain your original amount. But, 30% is not too steep so you could recover and keep on making money. For someone wanting to risk less, a $300 loss on $2000 would be a 15% loss. So, if that person with $2000 was trading 2 mini lots at a time, they could reduce their trading size to 1 mini lot and cut their drawdowns in half. However, if someone wanted to be very aggressive, let's say he risks 5 mini lots per $1000. He could do this if he thinks he has an iron-clad method that only produces 3 consecutive losses in a row. (Whether this is possible for anyone to trade like this is not the point, just showing the math.) If he had 3 consecutive losses, he would have a drawdown of 45%. [That's 5 (mini lots) times $30 loss = $150 times 3 losses = $450.] This way, if he has a $60 gain for every mini lot, he'd end up with $300 (5 times $60) which would represent a 30% gain on his total amount in one single trade. So, you can see that trading size 5 times larger really multiplies your money faster. Of course, you can adjust and play with the figures and percentages as much as you want, they're just examples. But, you see here that your maximum drawdowns depend on two things: the number of consecutive losses you have and the size of the stops you use (where you cut your losses).
Just a passing note though, if someone had three $30 losses and two $60 winners, then you'd have a profit of $30. That's $120 of profits minus $90 in losses = $30. So, in this case you'd be right only 40% of the time and still making money. This is with a 1:2 risk/reward ratio. In other words, risking $30 to make $60 means risking 1 dollar to make 2.
So, in my opinion, if you wanted to make the most amount of money in the least amount of time, you'd want to have a method that gives you fewer consecutive losses, allows you to have tight stops (a method accurate enough to give you very favorable entry points) and a favorable risk/reward ratio (meaning tight stops is only one factor, you'd want to have a method capable of capturing twice the profits than what it gets in losses). Trade frequency is another factor. If you only traded once per year and had 10 consecutive losses, that would mean losing for 10 years. However, if you made 1 trade per day, 10 consecutive losses would only mean losing for 10 days. And going down to 1 minute candlesticks for example could result in many more whipsaws (false signals). Well, you can figure out the rest from there.
Thanks for the replies.
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