Discussion in 'Risk Management' started by turkeyneck, Oct 11, 2008.
Why you should always use percentage and never use dollar amount in risk/drawdown management?
Because the stop should be based on price action not on a fixed dollar amount.
Risk management is paramount in trading so if you must reduce trading size to meet risk management and price action guidelines, do so.
Don't set targets on dollar or point values. You're done once you start thinking about money. Trade for the technicals and you'll be consistently profitable.
Always think in percentages.
One place where "dollar amounts" are appropriate (in my opinion) is in screening out instruments whose volatility is too low.
I apply this idea in fully mechanical trading systems, that trade portfolios containing hundreds of instruments. At some times, some instruments just plain move slower than others; their volatility is low. The very lowest volatility instruments are unlikely to generate profits significantly greater than the commission cost of trading them. I prefer for my systems to skip those trades.
So I like to include a rule in my mechanical systems, which compares the recent price volatility of an instrument (converted into dollars) against the per-lot commission paid to trade that instrument. If volatility is less than (m times commissions), skip the trade. The multiplier "m" lets you choose whether you want volatility > 2xCommissions (m=2), or whether you want volatility > 1.25xCommissions (m=1.25), or some other choice you might make.
However, I do agree with previous posters in this thread, it is unwise (meaning: test results are poor!) to set stops or profit targets based on "dollar amounts".
I agree with trade the charts and not profit and loss. Too many mistakes are made by hand wringing over watching your profit and loss while the charts are telling you where everything is headed.
All my risk management stops are based on chart technicals. I don't care how much is lost because I already know what my risk/reward ratio is before ever entering the trade. Probability will always be on your side if you have an edge.
Could you explain this in a little more detail? Even edges can be wrong so, how do you determine your stop? Can you give an example? Thanks...
Because $5000 is one man's 2% risk and yet another man's entire account.
Pattern failures or stops positioned under or over areas of major support or resistance determined through price action. This is no secret.
Instead of thinking in terms of how many times you're right or wrong it's better to think in terms of risk/reward ratios. You can be wrong quite a few times at 1:3 or 1:4
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