What Is "Proper" Risk/Money/Trade Management?

The second one is rather important. It has a lot to do with compounding. If you don't let winners turn into losers, then you protect your capital as much as possible. It's always easier to get to new equity with a maybe 5% drawdown than from a 20% drawdown. Even if you sacrifice some winners, it will probably do your equity curve very good.

Number nine I need to disagree with. Emotionally it may free you up, but it dramatically decreases the expectancy of most systems and might even make some systems into a losing system if you take (part of) your profits too early. Of course it depends on the metrics, but I sincerely have never seen a system where banking some profits along the way increased profitability.

my 2 cents.

Custos,

The compounding that comes with losing trades can be staggering. Might post some stats next showing the compounding effect of losses as we head on in to Risk Management.


Even if you sacrifice some winners, it will probably do your equity curve very good.

Now that's thinking about the bottom line.

Re: #9...I'm glad you disagree. It works for some to take half off (half of a position or trade), then have a "free ride"...very popular around here (FF). Yes...taking it too early can be trouble. Any numbers you have (maybe some you've tested) to show as an example?

Thanks for your 2 cents...in gold .

FX4

What does it take to recover your loss?

Now those percentages...

This table shows the percentage gain (shown on the right) that is needed to bring the account back to breakeven if it incurs the corresponding percentage of capital lost (shown on the left). Found this table here...Thank you Welles Wilder and Fti.

% Lost--------------------% for Recovery

05-------------------------5.3
10------------------------11.1
15------------------------17.6
20------------------------25.0
25------------------------33.3
30------------------------42.9
35------------------------53.8
40------------------------66.7
45------------------------81.8
50-----------------------100.0
55-----------------------122.0
60-----------------------150.0
65-----------------------186.0
70-----------------------233.0
75-----------------------300.0
80-----------------------400.0
85-----------------------567.0
90-----------------------900.0

These percentages give some insight into why it is sound trading wisdom to keep drawdowns and risk parameters to under 5% of your trading equity...and the lower the better.

I think this would be a good point to shift to Risk Management.

Comments/discussions welcome...


FX4

Another little something to think about (courtesy Robert Deel):

Series of Losses----------------Probability

3 losses in a row-----------------12.50%

4 losses in a row------------------6.25%

5 losses in a row------------------3.00%

10 losses in a row-----------------0.10% (1 in a 1,000)

Please note that these probabilities are based on a 50/50 outcome, like flipping a coin. The market can and does provide diverse opportunities for these probabilities to vary.

What is important to keep in mind is that the more trades you place (overtrading), the greater your chances of having consecutive losses. And, if on those consecutive losses, you do not keep your risk very low, you could find yourself on a slippery slope to a blown account.

So, what's the wisdom? If you're going to put your money at risk, pick the very best of the best trades (per your system) and keep your losses to a bare minimum (risk management), while maximizing profits (money management) when things are in your favour. That will help any trader to go a long way in this business.

FX4

Now that those percentages are up, let's go on to talk about risk.

From Wiki...(underline mine)

Risk is the potential that a chosen action or activity (including the choice of inaction) will lead to a loss (an undesirable outcome). The notion implies that a choice having an influence on the outcome exists (or existed). Potential losses themselves may also be called "risks". Almost any human endeavor carries some risk, but some are much more risky than others.

Trading for sure is one of those "riskier" endeavours.

So, in trading what are we risking? Ultimately it is our capital that we are trying to protect from loss. Our egos, emotions, reputations etc. are also on the line, but that's another topic altogether. Some have even lost their families. Alot is at stake here. Given the dynamics of human nature, price action, and the unexpected, certain risk management measures to protect/preserve our trading capital are available.

The use of Stops Loss Orders is quite common. Trailing Stops are Profit Protection mechanisms.

We'll discuss these next week with some scenarios.

FX4

I don’t disagree outright with the maxim “never let a winner become a loser”. However, I submit some provisos and caveats for everybody’s consideration.

At the ‘conservative’ end of the scale, never letting a winner become a loser means moving the SL to breakeven immediately a trade is 0.1 pip in profit. Obviously, this is taking the maxim to a ridiculous extreme, as it would mean that a vast number of our trades would get stopped at zero profit, which (over a series of trades) would create the worst possible RR profile. But it begs the question: if we want to let our profits run beyond breakeven, exactly how much room should we give our trades to move freely? And extrapolating, should this apply merely to breakeven, or also subsequently, i.e. locking in profit as a trade progresses?

Now let’s look at the other end of the scale: the possibility of ‘infinite yield’. Methods like DIBS (Joel Rensink/Peter Crowns) and ‘Building an equity millipede’ advocate letting profit run as long as possible. If I understand correctly, Graeme the millipede trader has open trades that he entered 2-3 years ago, for 10-20 pips initial risk, that are now thousands of pips in profit. These trades encountered significant retracements along the way, necessitating a VERY wide trailing SL (or move it no further than breakeven).

For me, the two extremes highlight the crux of the matter: The trader needs to somehow find the optimum compromise between protecting profit made to date, but without overly curtailing the possibility of further profit, relative to his chosen trading horizon.

Some more ideas to ponder:

It’s my view that each pip gained (or lost) is equal to every other pip gained (or lost). Why is this important? Well, it’s easy to think along the lines of “My trade is now 100 pips in profit, I can now afford to risk X of those pips, because I’m playing with the market’s money”. But if those X pips risked are subsequently lost, that has exactly the same eventual effect on bottom line as any other X pip loss. Even though we didn’t let a winner become a loser, we still lost X pips, just as if we’d lost X pips (in another scenario) by letting a winner become a loser. That’s why I query the “never let a winner become a loser” maxim, per se; and also why I believe it’s a fallacy to believe that we’re ever “playing with the market’s money”.

Breakeven may be of huge importance to us, but the market takes no cognizance of our personal and arbitrary view of our own profits and losses. Hence I would argue that, for trade management to provide any kind of edge, it must either have some kind of TA-based, or otherwise statistically proven (read: vast experience) backing. Otherwise, all of our trade management decisions are merely guesswork, and until proven otherwise, have no better than a 50/50 probability of ultimately improving or worsening our bottom line. My own trading experience bears this out. About 50% of the time, I would have been better off by trailing a tighter SL, thereby forfeiting less profit on price retracements; about 50% of the time, I trailed it too tightly, choking future profit. Without objectively analyzing a vast number of historical trades, I really have no idea how tightly I should trail my stop, and consequently I’m gaining no real edge from my trade management. Re trade management, the only useful knowledge that I’ve picked up in my 5 years of forex, is to be more willing to let profits run when price is trending strongly, and take profit earlier when it’s not. Apart from that, any success that I’ve had must necessarily rest with the efficacy of my entries.

Ideally, trade management should be a dynamic process. With a currently open trade, the only edge I have at any point rests with my ability to forecast what will happen in the immediate future. If the probability > 50% that price will henceforth move favorably, then I should keep the trade open; otherwise, I should close it. Given that every pip is created equal, that necessarily holds true regardless of whether the trade is currently +50 or –50. If I have no idea which way price will move henceforth, then it makes no difference whether I close the trade or not: everything else being equal, around 50% of the time it will be a ‘good’ decision, and around 50% of the time, it will be a ‘poor’ one.

Finally, given all of the above, how important is RR? For example, suppose I open a long trade with a 100 pip TP and 50 pip SL, i.e. 2:1 RR. Now let's suppose price subsequently rises 90 pips. If I haven't moved my SL, I'm now risking 140 pips to make another 10 pips. If I wouldn't be willing to take on that proposition by opening a trade here, then why should I do it now? In my view, that is not only an obvious case for advancing the SL, but it highlights to me that RR changes dynamically as a trade unfolds. At this point, the RR that was taken at the original entry point is largely irrelevant.

Rather than hijack this thread further with my rambling, I’ve covered all of these points (and more) here.

David

Great post Hanover...and the link to your other one as well. Will comment later when I can give it another read.

Thanks,

FX4

My personal money/risk managment is to risk 5% over 100 pip emergency stop.

I leave the TP open, lock in my first target and let run after that.

That allows me to make some decent money when I only get 10-50 pips and when I hit home runs the profit is very nice.

I have a stop yes, but I do move it. I use a recovery method. At -100, provided I havn't been stopped out by a big sudden spike. I will move the stop out to -200 and look for another entry around -100. The second entry will be at double the size, so that if and when it comes back I can take both the positions out at BE, OR if I think it will keep going leave them on for my original target.

I can do this because I'm currently trading AL's TMA method. So, my entries are always on/after a short dip for long and a long spike for short. So, price has already spent some of itself in the opposite direction of my trade direction. Basically buying the dips and selling the spikes.

I've found The TMA method has cured my worst trading habit/mistake. That is, chasing price, seeing it go up or down and break some resistance and jumping in, only to see it reverse

Back again Hanover,

The two extremes you highlighted were good ones .

For me, the two extremes highlight the crux of the matter: The trader needs to somehow find the optimum compromise between protecting profit made to date, but without overly curtailing the possibility of further profit, relative to his chosen trading horizon.

Sometimes traders forget to consider their "chosen trading horizon" which is an important factor.


It’s my view that each pip gained (or lost) is equal to every other pip gained (or lost). Why is this important? Well, it’s easy to think along the lines of “My trade is now 100 pips in profit, I can now afford to risk X of those pips, because I’m playing with the market’s money”. But if those X pips risked are subsequently lost, that has exactly the same eventual effect on bottom line as any other X pip loss. Even though we didn’t let a winner become a loser, we still lost X pips, just as if we’d lost X pips (in another scenario) by letting a winner become a loser. That’s why I query the “never let a winner become a loser” maxim, per se; and also why I believe it’s a fallacy to believe that we’re ever “playing with the market’s money”.

Isn't that a mindset for sure that comes up once we've made some +pips? I think it is a good idea not to think we're "playing with the market's money". If we don't own it in our minds FIRST, how will we take control of it and do what we can to keep it in our possession?

Breakeven may be of huge importance to us...

Very good point there in that paragraph. If a trader takes breakeven trades too often, overall what will they really have? More time to hope they are going to make it I guess. Some of the things trades have gotten used to for "security reasons" perhaps "are merely guesswork" until proven otherwise as you have said...like R:R before the fact.


Re trade management, the only useful knowledge that I’ve picked up in my 5 years of forex, is to be more willing to let profits run when price is trending strongly, and take profit earlier when it’s not. Apart from that, any success that I’ve had must necessarily rest with the efficacy of my entries.

Good point! By the way, were there any hurdles you had to overcome to "let profits run", or anything you had to put in place?


Ideally, trade management should be a dynamic process. With a currently open trade, the only edge I have at any point rests with my ability to forecast what will happen in the immediate future. If the probability > 50% that price will henceforth move favorably, then I should keep the trade open; otherwise, I should close it. Given that every pip is created equal, that necessarily holds true regardless of whether the trade is currently +50 or –50. If I have no idea which way price will move henceforth, then it makes no difference whether I close the trade or not: everything else being equal, around 50% of the time it will be a ‘good’ decision, and around 50% of the time, it will be a ‘poor’ one.

Finally, given all of the above, how important is RR? For example, suppose I open a long trade with a 100 pip TP and 50 pip SL, i.e. 2:1 RR. Now let's suppose price subsequently rises 90 pips. If I haven't moved my SL, I'm now risking 140 pips to make another 10 pips. If I wouldn't be willing to take on that proposition by opening a trade here, then why should I do it now? In my view, that is not only an obvious case for advancing the SL, but it highlights to me that RR changes dynamically as a trade unfolds. At this point, the RR that was taken at the original entry point is largely irrelevant.

Very logical....

Not hijacking at all...glossed over your list of points. Will go back to them again.

As always, good stuff!

Thanks,

FX4

Hello KumoDragon,

Like the idea of an "emergency stop". I also like your plan: Lock in first target then let it run. How do you feel when you're "letting it run" and it starts to retrace? Aren't you tempted to take your profit?

I have a stop yes, but I do move it. I use a recovery method. At -100, provided I havn't been stopped out by a big sudden spike. I will move the stop out to -200 and look for another entry around -100. The second entry will be at double the size, so that if and when it comes back I can take both the positions out at BE, OR if I think it will keep going leave them on for my original target.

Is that another stop? Seems not, but decided to ask anyway. At -100 pips...what TF do you trade if I may ask? Doubling up on the way back is a good idea...hopefully your edge is sharp enough that you "know" what and why on the entry. -200 pips is too steep for me...-100 is also alot, but maybe not as an emergency stop. I try to enter with as little roll around and heat as possible.

Buying on dips and selling on spikes...good approach. Doesn't always feel comfy to do...for some traders they will buy into the move up and sell into the move down...makes emotional sense for them.

Thanks for your post and comments.

FX4

Will be continuing with this topic soon.

FX4

fx4newbies,

You always ask some interesting questions. I will admit, I have not read all the posts in this thread, but a first glance I see the usual culprits in a risk thread: percentage of account at risk, moving stops, risk reward to a lesser extent, but an often over looked aspect of managing risk in an account is leverage.

Most new traders fail to understand the double edge sword that is margin and leverage.

Keep up the good discussions,

xt

Thanks Xt. I try to get traders to think by asking those interesting questions.

About those culprits...trying to introduce other ways to manage risk etc. can stir up quite a bit. Would love to hear your take on some of them.

Thanks for stopping by.

FX4

P.S. Sorry for taking such a long time to reply. Been very, very busy lately.

define "soon"

Hello Erebus,

Didn't mean for it to be this long...my apologies. Just have had one thing after another to deal with.

Will be posting this weekend.

Thanks for the nudge .

FX4

Okay...

Earlier in this thread a request was made to discuss different methods of money management. I think a discussion on the Fixed Fractional Method would be a good place to pick things up.

Fixed Fractional Trading is one of the more popular methods and is highly recommended by some for trading leveraged instruments. How does it work? Basically, if a trader is using this method, they will risk a certain percentage of their account on a trade and no more, regardless of what the market is doing. The pros and cons of using this method might also prove very informative.

Will go into more details during the course of the week.

Take care,

FX4

Will try to pick this up later this evening/tonight.

FX4

Update...will have to get to this on the weekend.

FX4

Hello again,

Here is something to get us going again...

The Fixed Fractional Method has its basis in one trade; that being the one that resulted in the largest potential loss for the system being traded. That somewhat presumes that the method has been back-tested (or uses the largest loss thus far)...mho.

So, let's say Joe Trader has an account balance of $50,000.00 and the largest potential loss trading his system on any one trade is $1,350.00. If he also decides that he will risk (lose) no more than 3% of his account on any one trade, then:

1. Joe Trader can risk up to $50,000.00 x .03 = $1500.00 per trade and no more! That is the amount Joe Trader is "allowed" to lose on the trade based on his account size and risk percentage he decides to use. In this scenario, his largest potential loss ($1,350.00) is less than what his account size and risk percentage can "afford" him to lose ($1,500.00) which isn't a bad place to be.

2. The minimum account balance needed to buy or sell 1 contract though (according to this method) would be: 1,350.00 / 3% = $45,000.00 ($1,350.00 / .03).

So, in this example, Joe Trader has enough capital to place the trade of 1 contract.

NOTE: Leverage, which is very common in FX, is not mentioned here.

An industry "rule of thumb": Trade one contract per $10,000.00 in the account derived as follows:

$1,000.00 (largest potential loss) / 10% (.10; percent risked on trade) = $10,000.00 (minimum account balance). That means with no leverage in FX, you can at least trade a micro. Now who does that with a $10,000.00 balance!!!?? Under-capitalization is considered a major issue for traders by professionals. The less capital you have, the better of a trader and risk/money manager you have to be...and new traders just aren't there yet. Then throw in leverage, and you have blown accounts big time for newbies.

Will stop there for now. Other aspects of this method will be discussed next weekend.

Bye for now,

FX4

A trader in another thread asked about my stats. Here is the link to see them from my most recent Detailed Report for those who may be interested.

FX4