This is, in my opinion, an overly simplistic method. This market will not only chew you up, but swallow you and barf you back up...in a matter of minutes. Case in point: yesterday (11/7) you see the all-day symmetrical triangle forming on the SPX. Great. You wait for the breakout (hours). It definitively punches through to the upside, your buy point is hit, and the pavement is pulled from you a few minutes later. You get stopped out at a loss--and here's the real bitch--the market reverses yet again to bust through to daily highs right up 'til the close with that spit-in-your face ferver you know so well. So my point is that I believe the market we're in now is more sophisticated than simple support and resistance. I think big dogs are fading breakouts, particularly the obvious ones. It seems to me the market sprints to the most inconvenient and obnoxious level for the most obvious setups.
because if you think about it, it's really the same thing anyway. If you have 5000.00 in your account, and you risk no more than 200.00 a trade, well thats 4%. As your money grows, or decreases, that 4% will adjust. As the other poster said, dont think about the money because it will screw you up.
You got it! This is a good reason to try to figure out a way to set stops based on value rather than on technicals that make little sense at this point. Actually, the big dogs care about how much they make or lose. This means that technical levels are primarily determined by value.
The "Never Risk More Than 2% Of Account" rule has a fatal flaw in this market; overnight gaps. Unless you're strictly day-trading (which this market is ripe for at the moment) I don't understand how anyone can expect to keep initial risk at 2%. To properly size a trade, you would subtract the entry price from the stop loss price and divide that amount into what ever value 2% of your account is, thus telling you how many shares to buy. But what's an efficient way to go about adjusting the formula to adapt it to the current market environment which takes into account the historically high volatility and likely occurrence of overnight gaps if you want to swing trade?
Good points. But gaps can work for and against you and in high frequency swing trading they end up causing a variation of risk of zero-mean about the target value. Michael Harris makes a few comments regarding these and other problems of the risk percent method in this paper: http://www.tradingpatterns.com/PositionSizing.pdf I quote below a statement he makes that I think deserves some attention: "Application of the risk percent method for calculating position size requires that before a trade is opened, the exit price level is know quite accurately. Obviously, this method cannot apply to trading strategies with varying, or unknown in advance, exit price levels. This is a drawback of the method but it may also be an indication that effective risk management can only be accomplished with simple position exit strategies."
An interesting document, thank you for the link. I'm aware that gaps can work for or against you. This is certainly true. But holding overnight with the market so unstable as it's been, or holding around earnings announcements, begins to take on the characteristics of gambling. Unless you're privy to inside info it's nothing more than a guess as to how a stock is going to react to such events, and thus the reason I question the effectiveness or practicality of this risk management strategy. Not quite sure what you mean when you say "<i>in high frequency swing trading they end up causing a variation of risk of zero-mean about the target value.</i> If you're implying that it all evens out in the end, I disagree. Because we all know stocks fall faster than they rise. I also feel one or two major gaps against you can have a devastating effect on your trading (and bankroll) and shake your confidence to the point where one is afraid to jump back in the saddle. In other words, suffering huge losses from gaps and exiting a trade significantly below your original stop is not the same as taking a nice profit on a gap that works to your advantage. I'm also not quite sure what he means when he states "<i>it may also be an indication that effective risk management can only be accomplished with simple position exit strategies</i>" what does he mean by "<i>simple position exit strategies</i>?" What would be an example of a "simple position exit strategy?"
IMO, he means exactly that, exit strategies that allow you to know the exit price in advance, otherwise the risk is indefined and position size cannot be calculated. I think he mentions this earlier in the paper too. For example, a fixed nnumber of points or pips in the case of forex trading will do it. I have tried in the past exit startegies based on technical levels, indicators and chart patterns and it apears to me he is correct. For example, you go ahead and select a support level and you place your stop a few ticks below it. Then the market falls a few more ticks in addition and there you go. I also believe charts create many illusions and biased readings. I once contacted Michael Harris and asked him why he did not include ATR stops in his APS software (www.tradingpatterns.com). His reply was because they simply do not produce better results than simple point or percent stops. I need to do some studies to confirm that but he may be right.
Let me explain what I was trying to say. For the flexibility, since everybody think in percentage then it might work better to set the trailing-stop in term of percentage lost. If two persons have lost $1000 for each of them, where the total amount of the first guy is $10000 and the second guy is $100000. The feeling of pain isn't the same, the first guy will have the most pain. In term of percentage lost (say -10%) then the second guy would have lost $10000 to have the same pain as the first guy.