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Correct Money-Management using Price-Action (huhh??)

  • #1
  • First Post: Oct 9, 2006 10:18pm Oct 9, 2006 10:18pm
When I first learned about money management, I essentially learned two things:

1) limit your risk to at most 2% of your equity.

and

2) Plan your trade to gain atleast 200 or 300 per cent of what you're risking. If based on the technicals, that is not possible, then don't take the trade.

Then I read an extremely long thread about price action, and I've even started to use it myself. The problem is, when I see a potential trade to take with price action, it is hardly ever 200 or 300 per cent of my risk. Usually it's a sure fire way to gain a hand full of pips, from my experience.

Question: Am I not taking the right trades? Should I be looking for larger swings? Does this MM scheme need to be modified? HuhhH?

Some guidence please.

Thanks in advance.
  • #2
  • Oct 9, 2006 10:27pm Oct 9, 2006 10:27pm
The traditional theory of risk reward ratio trading is all bullocks to me to be honest. The market makes a habit of destroying the best layed out plan, so to attempt to "know" that your target is 3 times your stop is shooting at fairies in my opinion.

I think of it this way ... "have I given myself a great chance of winning than losing, and do I have a greater chance of winning more than I am risking" ... as simple as that, risk/reward ratios are all well and good but to me they mean little at the end of the day. I know this goes against the grain, but each to their own I guess.

A very simple classic example of this type of trade would be buying at support, you know your stop can be relatively close cause you are buying at a potential exhaustion point, and if support holds, then you can hazard a guess (cause that is all it is) that the move would be worthwhile enough to take the trade, whether you gain more than 300% of your stop distance, who know and who cares, let the market tell you when to get out.

Keeping the percentage of your total account at risk down though still has some merit, but really it is pretty easy to know if you are risking too much, just wait for that nervous squirmy feeling, that is when you know.
You can quit and they won't care, but you will always know.
  • #3
  • Oct 9, 2006 10:39pm Oct 9, 2006 10:39pm
Akuma99;
Thankyou for the honest answer. It's given me confidence. I'm still not qualified to answer a question like this but after 2 years of part time research I agree with your statment. Winning is what's importand. You can't frame the market into a perfect ratio.
  • #4
  • Oct 9, 2006 11:37pm Oct 9, 2006 11:37pm
Reward/Risk ratio? Oh yeah, that's that 2:1 or 3:1 thingy isn't it? I've been meaning to get around to studying up on that, but I've been too busy making money.

Reward is an unknown variable in my trades. Sure, my trades have profit targets, but whether price will actually hit those targets, I have no idea.

When I enter a trade, I do not know what my Reward will be (if any), but I do know what my risk is. My objective in every trade I make is to reduce and then eliminate the entry risk as quickly as possible. I'm not looking to make money. If I make money, that is a happy coincidence, but my focus is on reducing risk.

For example, let's say I enter a trade with an initial stop loss of 40 pips, which represents 2% of my equity. My reward is represented by R and is an unknown until after the trade is closed
Therefore my entry reward/risk ratio is R/40. If the trade moves in my favor, and I'm able to move my stop up by 20 pips, my reward/risk ratio then becomes R/20. I have no idea what the numerical value of R/40 and R/20 are, but I do know that the ratio has been doubled, and my risk has been halved.

If I am able to eliminate risk by moving my stop to break even, then my ratio becomes R/0 which has a value of infinity. I don't know about you, but I've found having a reward/risk ratio of infinity has proven to be profitable.

Dial
sxaxlxvxaxtxixoxnxbxyxgxrxaxcxexdxoxtxoxrxgx
  • #5
  • Oct 9, 2006 11:53pm Oct 9, 2006 11:53pm
Quoting Akuma99
The traditional theory of risk reward ratio trading is all bullocks to me to be honest. The market makes a habit of destroying the best layed out plan, so to attempt to "know" that your target is 3 times your stop is shooting at fairies in my opinion.

I think of it this way ... "have I given myself a great chance of winning than losing, and do I have a greater chance of winning more than I am risking" ... as simple as that, risk/reward ratios are all well and good but to me they mean little at the end of the day. I know this goes against the grain, but each to their own I guess.

A very simple classic example of this type of trade would be buying at support, you know your stop can be relatively close cause you are buying at a potential exhaustion point, and if support holds, then you can hazard a guess (cause that is all it is) that the move would be worthwhile enough to take the trade, whether you gain more than 300% of your stop distance, who know and who cares, let the market tell you when to get out.

Keeping the percentage of your total account at risk down though still has some merit, but really it is pretty easy to know if you are risking too much, just wait for that nervous squirmy feeling, that is when you know.
Hi Akuma99,

An EXCELLENT answer.

"Wanting" a trade to go to a certain price point is a sure way of blinding the trader to where it is really going. Certainly, the trader can be aware of "potential" target points but always be prepared for the fact that you could be wwwwrong. (It is always hard to say that word!!).
  • #6
  • Oct 10, 2006 12:00am Oct 10, 2006 12:00am
Quoting diallist
Reward/Risk ratio? Oh yeah, that's that 2:1 or 3:1 thingy isn't it? I've been meaning to get around to studying up on that, but I've been too busy making money.
OK so primary goal: eliminate risk. Achieve a free trade.

(Don't worry that you just lost 2 40 pip trades, and just won 3 worth 12?)
Quote
(My objective in every trade I make is to reduce and then eliminate the entry risk as quickly as possible.)

I suppose it also helps to have a system that is reliable. That sounds very obvious, but with a wildcard RR ratio, it's the only leg to stand on.

I will definantly use what you have shared. But you should know, */0 is undefined.
  • #7
  • Oct 10, 2006 12:07am Oct 10, 2006 12:07am
Quoting diallist
Reward/Risk ratio? Oh yeah, that's that 2:1 or 3:1 thingy isn't it? I've been meaning to get around to studying up on that, but I've been too busy making money.

Reward is an unknown variable in my trades. Sure, my trades have profit targets, but whether price will actually hit those targets, I have no idea.

When I enter a trade, I do not know what my Reward will be (if any), but I do know what my risk is. My objective in every trade I make is to reduce and then eliminate the entry risk as quickly as possible. I'm not looking to make money. If I make money, that is a happy coincidence, but my focus is on reducing risk.

For example, let's say I enter a trade with an initial stop loss of 40 pips, which represents 2% of my equity. My reward is represented by R and is an unknown until after the trade is closed
Therefore my entry reward/risk ratio is R/40. If the trade moves in my favor, and I'm able to move my stop up by 20 pips, my reward/risk ratio then becomes R/20. I have no idea what the numerical value of R/40 and R/20 are, but I do know that the ratio has been doubled, and my risk has been halved.

If I am able to eliminate risk by moving my stop to break even, then my ratio becomes R/0 which has a value of infinity. I don't know about you, but I've found having a reward/risk ratio of infinity has proven to be profitable.

Dial
Another EXCELLENT answer.

It is amazingly easy to see who the professional traders are on a forum. All you have to look for is the "NO BULLSH*T" answers.

No hidden "secrets", no attempt to sell something to newbie traders, all advice freely (and willingly) given, and a clarity and flexibility in their trading strategies.

Perhaps even more importantly, the most professional traders (as opposed to signal sellers) readily acknowledge that THERE IS NO HOLY GRAIL !!

Trading Forex is a war...you set out your strategy for your next trades, and then you go to battle. If you win, you get financially rewarded...if you lose, you are financially wounded. Keep the wounds superficial.
And each day is a new battle.

It is simple, but it is not easy.

Having said all that, if you treat Forex as a business, this is still the best business in the world.
  • #8
  • Oct 10, 2006 12:32am Oct 10, 2006 12:32am
Quoting 4X=0
OK so primary goal: eliminate risk. Achieve a free trade.

(Don't worry that you just lost 2 40 pip trades, and just won 3 worth 12?)


I suppose it also helps to have a system that is reliable. That sounds very obvious, but with a wildcard RR ratio, it's the only leg to stand on.

I will definantly use what you have shared. But you should know, */0 is undefined.
Hi 4X,

That's right. You don't have to worry about losing 2 40 pip trades and then winning 3 worth 12, IF you have a good R/R ratio on a SERIES of trades. As described in my previous post, it is not possible to know the R/R ratio of a given trade until after the trade is closed. But, once you have a series of closed trades that has been generated by the combination of your trader self, your method and your MM, then you can calculate your systemic R/R.

A "system" consists of TRADER+METHOD+MM. Changing any of the three can affect the series R/R.

Yeah, I "know" that */0 is undefined, but I have never understood why. To me it makes perfect sense that if you keep making the denominator smaller and smaller, the ratio gets bigger and bigger. In my view, an infintesimally small, but non-zero denominator yields a really huge number that is not infinite. So why doesn't pushing the denominator to zero, push the ratio to infinity? I don't get it.

Dial
sxaxlxvxaxtxixoxnxbxyxgxrxaxcxexdxoxtxoxrxgx
  • #9
  • Oct 10, 2006 12:40am Oct 10, 2006 12:40am
Quoting 4X=0

(Don't worry that you just lost 2 40 pip trades, and just won 3 worth 12?)

it's not you who can determine how much you will win, it's the market, so forget the maths,

first of, losing 2 40 pips is like one 80 pips, and 3 worth 12 is 36, 80 >36, basically here you have to worry because you screwed up.

and second of all, you should not judge the quality of trades you take by the risk/reward ratio, instead, use the probabilty of your forecast being true. for example, a trade with 4:1 risk/reward will seem unattractive to you, but not necessarily to me, Because I can take it if it's accuracy is highly probable.

finally, you have to be flexible, enter a trade and let it go, take profits at reasonable places, and put stops at reasonable levels as well.

good luck
Trading is a long and a short story.
  • #10
  • Oct 10, 2006 12:42am Oct 10, 2006 12:42am
Quote
To me it makes perfect sense that if you keep making the denominator smaller and smaller, the ratio gets bigger and bigger.

Yah that makes sense to me too, but there must be something about crossing from the infintesimally small into the non-existant.

Zero IS a number, but it is really just a symbol that represents nothing. And there is a huge difference between nothing and something.

As far as I can tell, turning your RR ration into */0 is infinantly awesome.
  • #11
  • Oct 10, 2006 12:44am Oct 10, 2006 12:44am
Quoting spinmypip
it's not you who can determine how much you will win, it's the market, so forget the maths,
It seems like RR ratio is a lagging indicator of your performance.
  • #12
  • Oct 10, 2006 12:52am Oct 10, 2006 12:52am
Quote
OK so primary goal: eliminate risk. Achieve a free trade.

(Don't worry that you just lost 2 40 pip trades, and just won 3 worth 12?)

That of course is too hard to answer without a context wrapped around it but I will say this. Most threads here, and all other forums focus on how to judge an entry, in reality an entry doesn't make you the money, the exit does, which ties into trade management (different from money management), and your exit is determined by how well you manage the middle of the trade.

Analysing a currency pair or any instrument should not stop once the trade is made, it should be followed with the same (hopefully) calm, patient and diligent state of mind you had when placing the trade. Let the market tell you when it is time to exit, don't you try to tell the market.

I always ask myself one question when checking on a trade:

"Has price given me a reason to close this trade?"

The markets talk you know, you just have to have the right translator.
You can quit and they won't care, but you will always know.
  • #13
  • Oct 10, 2006 1:05am Oct 10, 2006 1:05am
Quoting spinmypip
first of, losing 2 40 pips is like one 80 pips, and 3 worth 12 is 36, 80 >36, basically here you have to worry because you screwed up.
With all due respect, spin, this simply isn't true. Having five trades showing a net loss does not mean the trader screwed up. I have a good systemic R/R which makes me money over the long run, but I have occasional runs of trades showing a loss, where I've followed my rules perfectly. I certainly don't consider myself as having screwed up.

Dial
sxaxlxvxaxtxixoxnxbxyxgxrxaxcxexdxoxtxoxrxgx
  • #14
  • Oct 10, 2006 1:09am Oct 10, 2006 1:09am
Quoting Akuma99
Most threads here, and all other forums focus on how to judge an entry, in reality an entry doesn't make you the money, the exit does, which ties into trade management (different from money management), and your exit is determined by how well you manage the middle of the trade.

Analysing a currency pair or any instrument should not stop once the trade is made, it should be followed with the same (hopefully) calm, patient and diligent state of mind you had when placing the trade. Let the market tell you when it is time to exit, don't you try to tell the market.

I always ask myself one question when checking on a trade:

"Has price given me a reason to close this trade?"

The markets talk you know, you just have to have the right translator.
Hopefully it's okay for me to express my agreement.

I completely agree with the importance of trade management.
And the translation part regarding whether the market has given you the signal to exit.

And in trade management, you have to be prepared on what your signals for exit will be.
Therefore, it is important to know that the "translation" or "signals" beforehand based on the market action (i.e., "the market has crossed below a moving average" or "has retraced more than the 61.8% retracement", time for you to exit half your position, etc.).

There are a lot of exit techniques out there. One of the taskf of a trader is to pick one that suits you (just in case it's not implied, and of course, profitable in the long run.).

I like you Akuma!

My other thoughts on trade management:
- how often will you look back at your trade ? (my major basis points: 1) free time and 2) emotional tolerance)
- at what times will you return? (at the close of the bar @ 16:00, or at the start of a new bar, etc. My main basis point is my free time)

Okay, I just wanted to chime in my experience and my agreement with Akuma.
  • #15
  • Oct 10, 2006 1:28am Oct 10, 2006 1:28am
Quoting eastmaels
Hopefully it's okay for me to express my agreement.
GASP! It lives!!!

Where the HELL have you been East? I thought you fell off the planet!

Good to see you posting again!

Dial
sxaxlxvxaxtxixoxnxbxyxgxrxaxcxexdxoxtxoxrxgx
  • #16
  • Oct 10, 2006 1:57am Oct 10, 2006 1:57am
Quoting diallist
GASP! It lives!!!

Where the HELL have you been East? I thought you fell off the planet!

Good to see you posting again!

Dial
LOL... : I got burned out man... Had to reprioritize.
I suck at time management so posting at FF had to take the back seat.

FF's growth, let's just say, is too much to handle for me. So I'm staying on the sidelines.
  • #17
  • Oct 10, 2006 10:35am Oct 10, 2006 10:35am
Quoting diallist
Reward/Risk ratio? Oh yeah, that's that 2:1 or 3:1 thingy isn't it? I've been meaning to get around to studying up on that, but I've been too busy making money.

Reward is an unknown variable in my trades. Sure, my trades have profit targets, but whether price will actually hit those targets, I have no idea.

When I enter a trade, I do not know what my Reward will be (if any), but I do know what my risk is. My objective in every trade I make is to reduce and then eliminate the entry risk as quickly as possible. I'm not looking to make money. If I make money, that is a happy coincidence, but my focus is on reducing risk.

For example, let's say I enter a trade with an initial stop loss of 40 pips, which represents 2% of my equity. My reward is represented by R and is an unknown until after the trade is closed
Therefore my entry reward/risk ratio is R/40. If the trade moves in my favor, and I'm able to move my stop up by 20 pips, my reward/risk ratio then becomes R/20. I have no idea what the numerical value of R/40 and R/20 are, but I do know that the ratio has been doubled, and my risk has been halved.

If I am able to eliminate risk by moving my stop to break even, then my ratio becomes R/0 which has a value of infinity. I don't know about you, but I've found having a reward/risk ratio of infinity has proven to be profitable.

Dial
I do think this is a cute illustration of a breakeven floor level. It can be a powerful componet of any trading system. But the idea that risk is eliminated completely is erroneous.

First r:r is typically used to decribed risk to reward of the entire trade. It's then used most commonly with a win % to determine expectancy. I know you know this I'm just setting some groundwork.

Risk was 40 pips in your illustration and will be on the next signal as well (assuming the same setup). While you managed to eliminate intial risk by moving to B/E you still had to assume some risk to get into the trade. For the purposes of typical r:r calculations that risk is still a factor. You must gain 40 pips to gain 1R. No matter what happens in the trade that remains constant.

As far as calculating risk in a current trade (risk at the moment for lack of a better term) and the R/0 idea. You are still risking something. For instance, if you move your stop to B/E when you are +20 you are still risking 20 pips for some possible gain. I know that many brokers put this in a neat little category called unrealized profit. I really hate that term. Those 20 pips are yours. It is not "found" money. The only difference between the unrealized category and the realized is a click of the mouse. You must decide if you will close the trade (the only way to truely eliminate risk) or risk that capital for more gains. Risk still exists.

Concerning the idea that we don't know how far a trade will go and profit targets....

I've seen a bunch of smart traders make this statement and it always baffles me. Of course there is uncertainty in profit targets. There is also uncertainty in our entries but we assign probablities to those entries and accept that some will work and some will not.

It does not matter if you use fibs, ema crosses, fixed targets, % or multiples of ATR, price action, pivot points, S/R or any other exit method. They can all be measured and a probability of success understood for each. This is how you calculate a reasonably accurate R:R ratio.
Secret Identity: Bill Sullivan
  • #18
  • Oct 10, 2006 3:26pm Oct 10, 2006 3:26pm
Quoting diallist
With all due respect, spin, this simply isn't true. Having five trades showing a net loss does not mean the trader screwed up. I have a good systemic R/R which makes me money over the long run, but I have occasional runs of trades showing a loss, where I've followed my rules perfectly. I certainly don't consider myself as having screwed up.

Dial
I totally agree, I was talking about all else being equal. I mean not anyone can be recovered from a 5 losing trades in a row, you probably do, but not anyone.
thanks
Trading is a long and a short story.
  • #19
  • Oct 10, 2006 3:48pm Oct 10, 2006 3:48pm
Quoting diallist
For example, let's say I enter a trade with an initial stop loss of 40 pips, which represents 2% of my equity. My reward is represented by R and is an unknown until after the trade is closed
Therefore my entry reward/risk ratio is R/40. If the trade moves in my favor, and I'm able to move my stop up by 20 pips, my reward/risk ratio then becomes R/20. I have no idea what the numerical value of R/40 and R/20 are, but I do know that the ratio has been doubled, and my risk has been halved.

Dial
Dial, maybe that's the way you teach your dudes but the rest of the trading world is just the opposite and consider the intial risk to be 'R' not the reward as you suggest. You always know your R value. You can not know your R multiple until you've exited the trade since it is profit divided by risk. Regardless of the profit target most traders have some clue as to whether the trade in queston is worth risking their capital and engaging the market. You can read up on this in Van Tharp's Trade Your Way to Financial Freedom. The calculation is explained on page 144.
  • #20
  • Oct 10, 2006 4:18pm Oct 10, 2006 4:18pm
At the end of the day, don't get so darn wrapped up in, "Oh I could've made X amount of pips."

It's all about reducing your risk. In this business, before you put on a trade, you need to keep in mind that pips and $$$ are just perks of the business.

If you start thinking that way, then you will be successful. Otherwise, you'll continue to give money to those who get it.
Mr. Trend
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