Volatility-based Risk Management: future or past?

Discussion in 'Risk Management' started by Liberty Market Investment, Sep 20, 2020.

  1. Many traders are looking for the grail on the price chart. But does it make sense?
    Spoiler - no. And here's why

    For almost any trading system, there will always be a market where it's going to earn some profits. The trader just needs to wait for the moment when their system starts making money.
    Unfortunately, not everybody is strong in patience, probability theory and statistics. That’s why not every trader is able to survive till that moment. The result is always the same - capital loss.

    So the question is - what shall a trader do to achieve their trading goals?

    All trading systems can be divided into two types:
    1. Systms based on trading ranges. Trading systems based on bouncing off a price level, or a price extreme etc.
    2. Systems based on trading trends.

    There are times when a market is in a strong trend phase, other times, market can be in a tight range for a while. In any scenario, if you want to save your money you need a good RISK MANAGEMENT.

    One of the simplest ways of choosing your risk management is calculating the right trade size. Let's try the well-known turtles technique, where a risk per trade (taking into account slippage and commission) is 1%.

    If you get a 10% account drawdown, you cut risk for all trades to 0.5% per trade. If the series of losses continues by another 10%, the risks are halved again and become 0.25% per trade. The return to the previous risks occurs only when the deposit returns to the previous level.

    The advantages of this method:
    1. You loose only a fixed amount, regardless of the market situation
    2. If you have a trending system, and the market is flat, a timely reduced trade size will help you wait for a good trend that will pull your deposit to new heights
    3. If you get a profitable trades series, risks can be increased up to 2% per trade.

    How can you benefit from using this approach to risk management?
    *You stay afloat for an infinitely long time, which gives you an edge as compared yo an "average" other trader
    * You can show your nice equity curve to potential investors or easily pass an evaluation program in a proprietary trading firm

    How do you choose your stop loss to place stops correctly from the market point of view?"

    I think one of the greatest methods is to set a stop based on the current market volatility. The point is your stop loss will change according to the market conditions. Volatility is precisely the very characteristic that keeps pace with the market, so a stop loss bound with volatility always stays relevant, regardless of the ticker and time frame.

    As a universal volatility measure, you can take a well-known ATR (Average True Range) approach which was used by the "turtles". The Turtles used a 2 * ATR stop. Each trader can choose the ATR length of their liking.

    For example, if you want to maximize the amount of profitable trades, you can use 3 * ATR stop loss. It is unlikely that the market will hit it, granted that your entry point has been chosen correctly and you stick to a trading system that has shown some profitability in the past. If your risk management allows for longer loss trades series, you can go as low as 0.5*ATR. In any case, your stop loss automatically changes as you change your time frame or symbol traded.

    Let me wrap this up by repeating that you don't need to reinvent the wheel in risk management. Just follow what has proved to work. For any trading strategy, there is a market that will yield good profits, so cut your position size during tough losing periods and wait for your happy hour. Your patience will be rewarded.

    What is your approach to risk management? Do you use volatility as a measure for your stop losses or do you rely on fixed stop losses?
    murray t turtle likes this.
  2. %%
    Mine vary...….. included but not limited to a moving average.
    Funny you should mention that; i'm re reading '' Way of the Turtle'' But I haven't had time to completely test his 350 day moving average/looks fine on some of his charts:caution::caution::caution::caution::caution::caution::caution:
  3. %%
    A 350 period moving average could be helpful.
    A 20 month moving average can give some good vol clues. Some markets dont have 350 months of data...………………………………………………………………………………………..