50% chance of making 20% or losing 10%? that's a nobrainer. Statistically speaking, you'd be one lucky guy if everytrade presents you with that odd. Seriously. The chance of taking 4 losses in a row is .5 x .5 x .5 x.5 Of course there's a chance, but probability wise, you're way ahead. And like Michael said, Neke is a grown man. He's shown he can do this.
Thanks to all who took the time to reflect on this quiz. Let us assume each trade lasts exactly one week, and you can be in only one trade at a time. With 20% for each profitable trade, and -10% for each non-profitable trade,and with the chance of profitable trade being equal to that of an unprofitable trade, let's assume we use r as the leverage. The question becomes trying to determine the value of r that maximizes the return: (1+0.2r)(1-0.1r). Take the first derivative and equate to zero, the problem reduces to solving the equation: (0.2-0.1)=2*0.2*0.1r, which gives r = 2.5. This is the leverage that maximizes the return in the long run. (If the mathematics here looks fuzzy to you, just ignore the details and read the points I am trying to convey). Of course most brokerages will give you overnight leverage of only 2.0 for stock positions (which is my target instrument). I have simulated returns with different leverage for a 52-week period. The returns are 20% for 26 weeks and -10% for 26 weeks, the actual weeks being randomized. I have included details of a random distribution of weekly returns, starting from an initial 10K, and determined the returns at different leverage. The summary of the returns over the 52-week period are as follows: Leverage Total Returns Max Drawdown 2.500 2038% 92% 2.000 1804% 85% 1.000 640% 56% 0.500 214% 32% 0.125 37% 9% Some folks (including my well-respected acerbits) will take on the last scenario (12.5% of account staked for a 37% annual return with 9% drawdown). My experience, and the response of many, tells me that most people are contented with measly return because of the scare of a bad drawdown. I completely understand this. We are all human. However, I believe we should each seek out whether we have any edge (in this regard your historical results over a long period will be the best indicator), determine our pain threshhold, and then set out to make the maximum advantage of that edge consistent with our pain tolerance. Even though 2.5 leverage is the optimizing level from the example above, I would not trade it. I am still human, and will be psychological distabilized by a 92% drawdown, especially if it happens near the start of the journey: We do not want anything that will make us doubt our edge or even ourselves. I believe I trade at a risk level I am comfortable with. If I suffer a 40% drawdown and still achieve my 550% target, so what? I have posted this primer on risk/reward just to answer those that think I am headed for disaster. Of course the outcomes in real-life will be more like a distribution rather than a two-state possibility. The stock market is a risk-based investment, and I do not understand folks who think others are nuts for taking measured risk, just because it does not conform to their risk tolerance profile. Code: Leverage 2.5 2 1 0.5 0.125 Week Return 10000 10000 10000 10000 10000 1 0.2 15000 14000 12000 11000 10250 2 0.2 22500 19600 14400 12100 10506 3 -0.1 16875 15680 12960 11495 10375 4 -0.1 12656 12544 11664 10920 10245 5 -0.1 9492 10035 10498 10374 10117 6 0.2 14238 14049 12597 11412 10370 7 0.2 21357 19669 15117 12553 10629 8 0.2 32036 27537 18140 13808 10895 9 -0.1 24027 22029 16326 13118 10759 10 0.2 36041 30841 19591 14429 11028 11 0.2 54061 43177 23509 15872 11304 12 0.2 81091 60448 28211 17460 11586 13 0.2 121637 84628 33853 19206 11876 14 -0.1 91228 67702 30468 18245 11727 15 -0.1 68421 54162 27421 17333 11581 16 -0.1 51316 43329 24679 16466 11436 17 0.2 76974 60661 29615 18113 11722 18 0.2 115460 84926 35538 19924 12015 19 0.2 173190 118896 42645 21917 12315 20 -0.1 129893 95117 38381 20821 12161 21 0.2 194839 133163 46057 22903 12465 22 0.2 292259 186429 55268 25193 12777 peak 23 -0.1 219194 149143 49742 23934 12617 24 -0.1 164396 119314 44767 22737 12460 25 -0.1 123297 95451 40291 21600 12304 26 0.2 184945 133632 48349 23760 12611 27 -0.1 138709 106906 43514 22572 12454 28 0.2 208063 149668 52217 24829 12765 29 -0.1 156047 119734 46995 23588 12606 30 -0.1 117036 95787 42296 22409 12448 31 -0.1 87777 76630 38066 21288 12292 32 -0.1 65833 61304 34259 20224 12139 33 0.2 98749 85826 41111 22246 12442 34 -0.1 74062 68660 37000 21134 12287 35 -0.1 55546 54928 33300 20077 12133 36 -0.1 41660 43943 29970 19073 11981 37 -0.1 31245 35154 26973 18120 11832 38 -0.1 23434 28123 24276 17214 11684 trough 39 0.2 35150 39373 29131 18935 11976 40 0.2 52725 55122 34957 20828 12275 41 0.2 79088 77170 41949 22911 12582 42 0.2 118632 108038 50338 25202 12897 43 -0.1 88974 86431 45305 23942 12736 44 -0.1 66731 69145 40774 22745 12576 45 0.2 100096 96802 48929 25020 12891 46 0.2 150144 135523 58715 27522 13213 47 -0.1 112608 108419 52843 26146 13048 48 0.2 168912 151786 63412 28760 13374 49 -0.1 126684 121429 57071 27322 13207 50 0.2 190026 170001 68485 30054 13537 51 0.2 285039 238001 82182 33060 13875 52 -0.1 213779 190401 73964 31407 13702 Drawdown 0.92 0.85 0.56 0.32 0.09
If your systems works for you and consistantly makes profits, than congrats. But personally I prefer to take alot less risk per trade and quantify through higher # of trades. In the end, consistant profits is what matters.
I was married and/or had kids or was 10-20 years older, then there is no way I could stomach such risk...
Thanks for giving us some insight into your trading process and the logic and reasoning behind it Neke. I personally like a 1:1 risk/reward with 80% probability of being profitable. Plenty of opportunities day-in and day-out in the ES. After that, as we both know, it's all about the money management algorithms and letting time do its thing. Good trading, Jimmy Jam
Weekly Update for week 10 ended 5/4/2007 Just when I thought options is looking promising, and decided to scale up, I am handed woeful losses. Three option trades cost me 26K. Interestingly, had I stuck to MAEE (Mastercard May 125 Call) to the follow-on rally the next day, I might have made a killing. Once more I am reminded this (Options) is a stinger to my account. Now I will have to scale back substantially. The rest of my discretionary and automated trades made 10K,not nearly enough to make up for the losses. On a lighter note, after seven weeks of straight gains, this is probably a welcome correction ...How is this for a consolation? Code: Balance B/F: 196,704 Loss for the week -15,424 Cash Withdrawal -6,000 ------------------------------------------------ Balance C/F: 175,280 Number of Trades 40 Number of Profitable Trades 24 Since Inception of Thread 2/25/2007 - 5/4/2007 Balance B/F: 76,636 Net Gain (Less Margin Interest) 117,644 Cash Withdrawal -19,000 ------------------------------------------------ Balance C/F: 175,280 Number of Trades 268 Number of Profitable Trades 175 Expected Balance at this time to be on track for Year-End Target : 117,370 Status: Ahead of Target Top/Bottom Discretionary Trades for the week TICKER ENTRY DATE/TIME EXIT DATE/TIME QTY PURCHASE AMT SOLD AMT GAINS TYPE JDSU 2007-05-02-18-11-35 2007-05-03-14-57-14 18000 256032 263800 7723.9 SHORT ISPH 2007-04-30-09-34-35 2007-04-30-10-09-15 14331 114004.4 121269 7212.8 SHORT MAEE 2007-05-02-11-44-08 2007-05-02-13-57-51 10000 48000 40000 -8170.6 OPTION GQRQK 2007-05-02-09-31-43 2007-05-02-14-03-09 20000 19970 8015 -12315 OPTION
Great work in the past weeks, nebe! I have read through from page 1 of this thread to the last page here. Impressed. I'm a new in stock, wish I could do as well as you! Though long way to go, I don't even get the start capital for US account right now! (BTW: I am a foreigner, exchange rate blocks me from start)
Hey neke, logic tells me that if you're giving up losses in your option trading that the wise thing to do would be to stop trading options? Other than that, this journal is quite interesting...and yes, i have read a few times that a correction usually occurs after a string of winners. I know that just happened with my own trading.
I scale down on a method (like OPTIONS) when I have severe losses. But I do not give up entirely, since I still feel it is a potentially profitable strategy: I just need to find the way to play it right. Until then, reducing my size is my way of controlling the risk.