3:1

[candletrader]

In my view, trading is 95% psychological... for those of us who don't like to be wrong as often as we are right, 3:1 may not be psychologically possible...

A lower expectancy achieved with 1:1 and 80% hit rate for people who "need to be right" may be the way to go, rather than a higher expectancy 3:1 and 50% hi rate...

Having said this, 3:1 is a sound approach, but only if you are psychologically prepared for the win rate% implication and can consistently deal with it over the long run...

Fwiw, excellent post acrary (as usual)...

 

[EMini-Player]

Quote from Harry123:

Fasttrader that would be exactly what you should be doing if your allowing yourself to take a 2 point stop loss. It may sound weird like 6 points is just too much and it may make you have to hold the ES all day sometimes and that may go against your mental makeup. (Not trying to insult you here). However that is what should be done. 6 points for a 2 point loss. If you were right on 50% of your trades then bamm your up :

No insult taken. Another problem is, I only trade the first 1-1.5 hrs of market open so I can not hold my trades as long as I'd like to. When it's time for me to leave for work, I go flat regardless of where my position is. My current platform does not support OCO orders so I can't just enter a stop and a target and leave my PC.

-Fast

 

[Error 404]

To trade with an arithmetic expectation as discussed, trailing stops are essential. Letting a decent winning trade turn into a losing trade is, IMO, the single biggest error inexperienced traders make. Of course trailing stops lower the percentage of "full target" winners realized.

So while shooting for a 3:1 w/l ratio in units as expressed in points made or lost, it is, (in terms of a simplified "system" of target trading) just good risk and money management to start a trail at a one unit profit. This makes a w/l rate on all trades of 50% at least potentially, if not most likely profitable. Which is really the whole idea of trading.

Expecting to have more winning trades than losing trades is a completely different thing, and far more difficult for any trader. But particularly so for less experienced traders. Far far more difficult.

Peace,
RS

 

[Harry123]

Quote from Harry123:

Im in a good mood tonight Wareco. I am going to agree with you 100% its total unrealistic. There is no way your are going to make 6 points on half your trades without at least the understanding beforehand that this range is going to require that you learn how to hold futures overnight.

So lets be more realistic: Lets say a 2.5:1 ratio on an absolute amount of points such as:

1.5 point stop loss and a 3.75 point gain on the ES. Furthermore the ratio will have to be even more condensed by assuming that to have this strategy work you have to take more than 1 contract lets say you trade 5 ES at a time. Then to make it even more realistic. Once you are up 1.5 ES points on a trade of 5 lot ES you take off 2 ES no questions asked. Then you move the stop on the ES up to .5 under your cost and let the rest ride to the final gain no matter what or stop out on the final 3 ES at .5 loss on the remaining. Now that would be much more realistic: lets see where that brings us too with an example:

Lets say because your looking for a gain of 3.75 points with a 1.5 point stop on the ES and your utilizing 5 ES contracts per trading opportunity you will probably find about 30 choice opportunities per month if your dilligent.

Then with that being understood lets do the math and assume once again a 50/50 win/loss ratio.

Lets say scenario one is a pure basis where you are either only stopped out or only reach target. That would mean that a winning trade would work out as follows on a 5 lot: 2 ES sold for 3 ES point gain the remaining 3=sold for Total gain of 11.25 point gain. For an absolute total number of points = to 14.25

Now the losing side of the equation is a bit more tricky due to more variables so lets make an assumption using averages. Scenario #1, 50% of the time the trade will never even go 1.5 points profitable in your favor and you will get stopped out on 5 contracts at a 1.5 point stop loss for a total loss in ES points of 7.5 The other 50% of the time you will get out of the ES on 2 contracts when its 1.5 points up in your favor for a total gain of 3 points but the remaing 3 contracts will fall back and cause you moved up to the stop loss your out on your newly moved up stopped loss for a .5 stop and a total loss of 1.5 points. That comes out to actually making a net of +1.5 ES points on this loss scneario # 2. Now loss scenario # 1 and loss scenario # 2 need to be averaged together as on a purely radom basis if you go in to an ES trade without even an edge 50% of the time you will be up 1.5 points and the other 50% of the time you will be down 1.5 thats the beauty of this method. With that stated the total loss side of the equation will now be .5(-7.5)+.5(1.5)= -3 ES points loss on average utilzing 5 contracts on each trading opportunity.

Now with have the win and loss side of the equation lets add of the figures:

30 trading opportunities: win loss ratio of 50%. Each trading opp we trade with 5 ES contracts. Now the reward/risk ratio becomes 14.25/3= 4.75 not bad.

In terms of money 15 times when we win we make 14.25 total points at 50 bucks per point that is = $10,687.50

The other 15 times when we loss we loss on average 3 total points at 50 bucks per point that is = $2,250.00

Total Gross gain now = $8,437.00

Net gain with commisions on total contracts traded assuming 2.4 per contract would be $7,717.00 net gain per month on this strategy.

This strategy also has a better than average chance than the first one I mentioned to be able to only be traded during the day as it takes in to account the average true range of the ES. Furthermore, more trading opportunites will show up because your looking for a lower range of points. Lastly, this method takes in to account the realism of taking some of the money off the table when your up and moving a stop loss up to near breakeven when your trade is in the green. Thanks again

I created a simple excel spreadsheet that will show all the different net profit results from this type of money mgmt strategy outlined above. The spreadsheet shows 4 different winning %'s from the spreadsheet you can see that even with as low as a 20%/80%, win/loss ratio you would at worst be at breakeven after commission. Very interesting results here. Remember this is all based upon 5 ES contracts, 30 trading opportunites on a monthly cycle. Results are gross and net for a months time.

Here is the attached spreadsheet. Enjoy.

 

[OddTrader]

Just curiously:

Should we trade comfortably with a (historically) profitable, reliable and consistent system of winning (say) 65% accuracy and wins lesser than 3 times (say 1.5 times) the size of losses, as the ratio might be probably (who knows?) the best possible returns that would be allowed from a particular market? If yes, then why 3:1?



BTW:

When some would suggest even not to guess the market's directions with high certainty, how could we newbies (without much foresight capability Yet) be able to measure, whether precisely or approximately, the ratio of a potential trade before placing a particular order? Any pointers of books/sites for reference?

 

[mind]

honestly speaking i never tried strategies of the mentioned. having said that i am eager to learn more on money management. thus i am interested in this discussion.

my principle reluctance on the subject is based on the thinking that the market will not behave differently just because my pnl has changed. my stops and the number of contracts must reflect my current risk appetite. i understand that first you have to define the amount you are willing to risk as a percentage of your capital, then you place your stop according to the current market (maybe volatility dependent), then you can calculate the number of contracts you want to trade.

now, i am reluctant to understand why i should do something just because my pnl has changed. when i add to a position it is simply another trade, independent from the first. when i reduce a position it is the same - just another trade. but i must not see these as bound together, because they must reflect my opinion on the market and the market does not know my pnl.

i think it is possible that concepts of pyramiding or deleveraging can work while they shed illusory light on the circumstances.


eagerly awaiting your correction of my mistakes in thinking ...

 

[steve46]

Putting on a position of 10 contracts with a stop of 10 points means a possible loss of 100 ES points or $5000. In Acrary's example this loser is followed by a winner that brings in 10 X 30 points or $15,000. Net profit of $10,000 sounds great. Problem is that winners and losers do not have to be distributed that way. What if you have a series of 10 losers in a row? Now you have lost $50,000. So in addition to looking at risk/reward ratio, the trader has to look at how much total portfolio "heat" he/she can tolerate. Position size of 10 cars would be appropriate for an account of x dollars depending on how many consecutive losers you hit before you start to see winners. In other words, you have to use a Monte Carlo engine to see how it plays out. This is exactly the reason undercapitalized traders get washed out of the game. There are only three ways to handle this, either scale down the position, scale down the stop, or don't trade that market. If you scale down the stop, you may get washed out because you are trading a noisy market (like the ES). So finally we get to a bottom line, which is this: you have to know how noisy your market is to determine the stop. The stop determines the position size and then the position size determines the account size. One opinion. Steve46

 

[Walther]

Quote from pspr:

Setting fixed ratios of risk to reward seems plausible but the implementation can give undesired results. For instance, if you are using a 2 pt stop and a 6 pt target with the ES and the market moves 4 or 5 points in your favor before reversing, you've just turned a good profit into a break even unless you also use some way to trail your stop. This will also lower your win percent since it is easier for the market to reach your stop than your target.

And, you will limit yourself from capturing much larger moves on trend days or trend afternoons.

This is why I believe the entry is the MOST IMPORTANT aspect of the trade. If your entry isn't good, market noise will often get your stop even on some of your good trades unless you use very wide stops. Then, with wide stops, the wider the stop the more you must get to average your 3:1 win/loss ratio.

So, I believe one must first select an entry point that 1) has a low probability of getting your initial stop hit and 2) has enough room to allow for a possible large win if the trade works.

And, the only way to keep winners from turning into losers yet not limiting your profit potential on a trade is to use trailing stops (manually under reaction lows or an automatic fixed point from the extreme move so far) OR use some type of method that tells you the move is over OR both. (Hint, often volume spikes portend end of moves except in the stronger trends).

I would like to see some of the seasoned pro traders of the ES comment on this as I too struggle with these concepts daily.

If you accept 3:1 as valid , it will inevitably leads you to a higher timeframes then those you are using now ( 5 min or less ? )to generate entry signals . You will need more capital and much more discipline to trade 15 or 30 min then 1 min, however that is the right way to do that .
Walter

 

[Harry123]

Quote from Walther:

If you accept 3:1 as valid , it will inevitably leads you to a higher timeframes then those you are using now ( 5 min or less ? )to generate entry signals . You will need more capital and much more discipline to trade 15 or 30 min then 1 min, however that is the right way to do that .
Walter

Exactly very true Walther. Scalpers dont worry as much about making 3:1 on their money. They were about frequency which will offset the mitigating results of a lower reward risk ratio such as what a scalper might be used to such as 1.4/1 or something like that. Higher reward/risk ratios should be saved for higher time frames. Higher time frame strategies will always require more money because of increased holding period times. Increased holding period times mean slower trading. Etc Etc.

By the way folks did u all get a chance to look over the Excel spreadsheet and that money mgmt idea. I am waiting for some feedback on it from you guys. Do you see it as good, bad or ugly?

 

[mind]

Quote from steve46:

What if you have a series of 10 losers in a row? Steve46

IMHO opinion every investment which does not provide risk free rate of return will go bust in the end. no matter how unlikely a streak of losses will be, once it will occur, it is just a question of time until such a streak rbings the account below the fixed cost for one contract and thus whipe it out.

now, for stable strategies this probability of bankrupcty might have its mean in five hundred years. depending on how aggressive you are playing your strategy you will end up somewhere between now and infinity with your mean probability of bankruptcy. you can freely choose where you want to position yourself within the limitations of your strategy. it is obvious that some futures traders who accept 30% draw downs twice a year will have a shorter expected life time than intraday traders who never loose more than 5%.

i think there is no real "answer" to your question, steve. i've seen quite a number of traders who did great figures year after year and suddenly went belly up. IMO they violated rule number one in any game: make sure that you stay at the table. or within the above line of argument: their probable period until default was too short.