Quote from illiquid:
Increasing risk after a loss would make sense to me in a game such as blackjack, where presumably if a greater number of "negative-count" cards have been dealt so far, the player would have probably experienced a "drawdown" in equity for that part of the shoe; however, this now leaves the rest of the shoe rich in "positive-count" cards aka 10's, which is favorable to the player and would require him to raise his bets. In trading, I don't find a logical connection such as the above in raising one's "bets", whether via size or wider risk parameters, based on previous losses.
I could see the reasoning for possibly reducing one's size after a series of gains for a certain type of trading -- however, in this case the reverse situation of increasing risk after losses would not apply either.
Illiquid,
To borrow your blackjack example, lets look at this.
If go to the table with 10 000, bet 1 000, and lose, and then if you bet 1 000 a second time, you have in fact just increased real risk because by betting 1K on you remaining 9K is risking a larger % of your capital (1K of 10K = 10%, and 1K of 9K = 11%).
In regards to the cards being dealt, I presume that you are saying that the odds of winning can be increased once the poor cards are out of the game. A similar idea can in fact be applied to the market. For example, every move higher in the market takes price all that much closer to a correction/reversal point. Ok, before I get stoned now, of course the big difference is that a deck of cards is finite and the number of cards know in advance whereas the market can trend against you for an unknown distance. In consideration of this latter point, we can thus conclude that whatever trading/management style one uses, the market can hand out a long losing streak and eventualy blow you up. A long losing streak is not just some theoretical possibility that might happen, it WILL happen sooner or latter in one's trading career. Well that is precisely why I have put so much time and energy into risk management and have come to the conclusion that increasing risk after a loss is the better bet.
Furthermore, as you may have picked up on this during this thread, my management style is not simply a mathematical formula that disregards the market. It is greatly based on the volatility that the market exhibits as my position size (not necessarily risk) tends to increase in low volatility zones, and decrease in high volatility zones. One observable fact that supports this aproach is the fact that volatility can only decrease so much (in theory, volatility can decrease down to the size of the bid/ask spread), whereas volatility can increase infinitely.
What would happen if one were to DECREASE risk after a loss? Well, after a relatively long losing streak, the risk taken on might get so low that just making it back up to highwatermark (break even) may become a titanic feat, may take a very long time, and may even become highly improbable.
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