Is the current Trade Planning and Trade Management a farce?
- Thread starter Rabbitone
- Start date
I'm looking forward to this new approach not found in popular books by famous authors.
Let us not waste ET bandwidth and our time, just give us the formula and we will let you know what we think.
First the formula and then the explanations please.
Thanks you all for your remarks. I hear you. Give me time to build up to how this works. Lets start with what we all see every day. The text below was stripped off a web site. It does not matter which one. But this calculation is plastered all over the web and in book after book.
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Applying the 2 Percent Rule
1. Calculate 2 percent of your trading capital: your Capital at Risk
2. Deduct brokerage on the buy and sell to arrive at your Maximum Permissible Risk
3. Calculate your Risk per Share:
-Deduct your stop-loss from the buy price and add a provision for slippage (not all stops are executed at the actual limit). For a short trade, the procedure is reversed: deduct the buy price from the stop-loss before adding slippage.
4. The Maximum Number of Shares is then calculated by dividing your Maximum Permissible Risk by the Risk per Share.
Example
Imagine that your total share trading capital is $20,000 and your brokerage costs are fixed at $50 per trade.
1. Your Capital at Risk is: $20,000 * 2 percent = $400 per trade.
2. Deduct brokerage, on the buy and sell, and your Maximum Permissible Risk is: $400 - (2 * $50) = $300.
3. Calculate your Risk per Share:
If a stock is priced at $10.00 and you want to place a stop-loss at $9.50, then your risk is 50 cents per share.
Add slippage of say 25 cents and your Risk per Share increases to 75 cents per share.
4. The Maximum Number of Shares that you can buy is therefore:
$300 / $0.75 = 400 shares (at a cost of $400)
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Every trader new or experienced is given the impression from these web sites and authors that a 2% formulation will provide your style of trading adequate money management. I did not find this the case. Let us examine a case where using rules like this causes extensive damage to a newbie's traders account.
Let us use this 2% rule for day trading. For example a new trader decides they will become a stock day trader. After extensive reading they decide to adopt this 2% rule to trade stocks intraday. They build an edge or setup they see happen repeatedly all day long. It seems to work half the time. The half that works makes great profits. On the first day of trading they have trouble executing (greed got to them and they took profits early) and they are down about 4% of their account by noon by not following the setup. But they are feeling good because they took all of their stops. Then in the afternoon it happens. They get a string of 4 losers in a row and they are down 8% plus the 4% loss from the morning. They are now down 12%. And they do what many rookies do; they panic - to try to get their money back (panic was added for realism). In the last hour of trading they wipe out another 5% for a loss of 17% in their first day of trading. They are dejected
Next the âNewbieâ comes to ET and starts a thread âWhat did I do wrong?â
For which the âNewbieâ is pulverized to ashes for their rookie mistakes. The newbie is told the 2% stop ridiculous, but no one gives the newbie a clue on how to fix this problem.
I was faced with these same problems before I built my own method. So what is my alternative method to this type of money management trading procedure? Here are some of the basic rules I use to define money management:
Rule 1: The percentage of the capital at risk is constantly changing based on market conditions. It must be adjusted based on the performance and characteristics of the strategy in a defined period of trading.
Rule 2: A defined period of live trading will be built to judge the capital risk. Data must be gathered for a defined period from optimizations, paper trading and live trading that defines the risk patterns of strategy being traded
Rule 3: The percentage of the capital to risk is generated from the goals set in the plan for defined period of trading. Loss management is the crux of the business plan.
Rule 4: Adjustments to capital risk will use prior periods as there baseline performance.
My rules are not that hard to use. They just look a little complicated. Now let us apply them. Note: this is a simple example to show the process.
Now we will to try to fix the newbieâs problem. Letâs tackle the 8% drawdown. Instead of live trading I would have told the newbie paper trade to gather stats about their trades from their edge. From this we will define:
1. The number of consecutive losers expected. (The stats from paper trading say 4)
2. The period of live trading for performance. This is the exact number of trades we are going to use to judge performance. I like this to be a 2 or 3 times the number of consecutive losers if possible. (We average 7 trades a day so every 14 trades or 2 days is the performance period).
3. The maximum capital risk or drawdown for a performance period in the plan (In a 2 day period the maximum risk per drawdown is 2.5%). Note this takes some experience to decide how capital risk will be planned for.
4. The trader also decides in their business model in their plan that if the account draws down to 5% during any week we are done for the month.
So now we have decided that 4 consecutive losers can have a max drawdown of 2.5% in a performance period that means the capital risk is .625% per trade on our $20,000 account or $125.00 a trade.
What the newbie day trader discovers is $20,000 is not going to go to make you a lot of money if your risk is inline (but thatâs another issue). I would then go back and test this using paper trading. Then this model is live traded. If results are out of line in the 2 day performance review we change our business models and either retest or start live trading again.
This is an iterative process to drive actual results in line with the expectations in our business model. There are many variations that can make this work. All of these depend on how the trader builds their business model. Mine are more complex than this simple example. And yes itâs a lot of work. But the end result is worth it.
The important thing is our business model dictates how much risk we take on and not some arbitrary 2% rule that we are duped in using as the gospel. I donât day trade. I am a full time swing trader using automated trading systems.
By telling traders these things am I worried? LOL. Forty percent of the newbieâs who trade will die off from their psychological traumas alone. Another forty percent will never figure out an edge. Another fifteen percent will not put a working business model together to manage their edge. So here we are the same 5% making all the money.
I have many more examples of trade management. But first tell me your thoughts and taunts.
And Trader3cnd if you have not guessed by now - it is not a formula. It is a process; a process to force your trades to meet your business model of how you want to make or lose money.
------------------------------------------------------------------------------------------------------
Applying the 2 Percent Rule
1. Calculate 2 percent of your trading capital: your Capital at Risk
2. Deduct brokerage on the buy and sell to arrive at your Maximum Permissible Risk
3. Calculate your Risk per Share:
-Deduct your stop-loss from the buy price and add a provision for slippage (not all stops are executed at the actual limit). For a short trade, the procedure is reversed: deduct the buy price from the stop-loss before adding slippage.
4. The Maximum Number of Shares is then calculated by dividing your Maximum Permissible Risk by the Risk per Share.
Example
Imagine that your total share trading capital is $20,000 and your brokerage costs are fixed at $50 per trade.
1. Your Capital at Risk is: $20,000 * 2 percent = $400 per trade.
2. Deduct brokerage, on the buy and sell, and your Maximum Permissible Risk is: $400 - (2 * $50) = $300.
3. Calculate your Risk per Share:
If a stock is priced at $10.00 and you want to place a stop-loss at $9.50, then your risk is 50 cents per share.
Add slippage of say 25 cents and your Risk per Share increases to 75 cents per share.
4. The Maximum Number of Shares that you can buy is therefore:
$300 / $0.75 = 400 shares (at a cost of $400)
------------------------------------------------------------------------------------------------------
Every trader new or experienced is given the impression from these web sites and authors that a 2% formulation will provide your style of trading adequate money management. I did not find this the case. Let us examine a case where using rules like this causes extensive damage to a newbie's traders account.
Let us use this 2% rule for day trading. For example a new trader decides they will become a stock day trader. After extensive reading they decide to adopt this 2% rule to trade stocks intraday. They build an edge or setup they see happen repeatedly all day long. It seems to work half the time. The half that works makes great profits. On the first day of trading they have trouble executing (greed got to them and they took profits early) and they are down about 4% of their account by noon by not following the setup. But they are feeling good because they took all of their stops. Then in the afternoon it happens. They get a string of 4 losers in a row and they are down 8% plus the 4% loss from the morning. They are now down 12%. And they do what many rookies do; they panic - to try to get their money back (panic was added for realism). In the last hour of trading they wipe out another 5% for a loss of 17% in their first day of trading. They are dejected
Next the âNewbieâ comes to ET and starts a thread âWhat did I do wrong?â
For which the âNewbieâ is pulverized to ashes for their rookie mistakes. The newbie is told the 2% stop ridiculous, but no one gives the newbie a clue on how to fix this problem.
I was faced with these same problems before I built my own method. So what is my alternative method to this type of money management trading procedure? Here are some of the basic rules I use to define money management:
Rule 1: The percentage of the capital at risk is constantly changing based on market conditions. It must be adjusted based on the performance and characteristics of the strategy in a defined period of trading.
Rule 2: A defined period of live trading will be built to judge the capital risk. Data must be gathered for a defined period from optimizations, paper trading and live trading that defines the risk patterns of strategy being traded
Rule 3: The percentage of the capital to risk is generated from the goals set in the plan for defined period of trading. Loss management is the crux of the business plan.
Rule 4: Adjustments to capital risk will use prior periods as there baseline performance.
My rules are not that hard to use. They just look a little complicated. Now let us apply them. Note: this is a simple example to show the process.
Now we will to try to fix the newbieâs problem. Letâs tackle the 8% drawdown. Instead of live trading I would have told the newbie paper trade to gather stats about their trades from their edge. From this we will define:
1. The number of consecutive losers expected. (The stats from paper trading say 4)
2. The period of live trading for performance. This is the exact number of trades we are going to use to judge performance. I like this to be a 2 or 3 times the number of consecutive losers if possible. (We average 7 trades a day so every 14 trades or 2 days is the performance period).
3. The maximum capital risk or drawdown for a performance period in the plan (In a 2 day period the maximum risk per drawdown is 2.5%). Note this takes some experience to decide how capital risk will be planned for.
4. The trader also decides in their business model in their plan that if the account draws down to 5% during any week we are done for the month.
So now we have decided that 4 consecutive losers can have a max drawdown of 2.5% in a performance period that means the capital risk is .625% per trade on our $20,000 account or $125.00 a trade.
What the newbie day trader discovers is $20,000 is not going to go to make you a lot of money if your risk is inline (but thatâs another issue). I would then go back and test this using paper trading. Then this model is live traded. If results are out of line in the 2 day performance review we change our business models and either retest or start live trading again.
This is an iterative process to drive actual results in line with the expectations in our business model. There are many variations that can make this work. All of these depend on how the trader builds their business model. Mine are more complex than this simple example. And yes itâs a lot of work. But the end result is worth it.
The important thing is our business model dictates how much risk we take on and not some arbitrary 2% rule that we are duped in using as the gospel. I donât day trade. I am a full time swing trader using automated trading systems.
By telling traders these things am I worried? LOL. Forty percent of the newbieâs who trade will die off from their psychological traumas alone. Another forty percent will never figure out an edge. Another fifteen percent will not put a working business model together to manage their edge. So here we are the same 5% making all the money.
I have many more examples of trade management. But first tell me your thoughts and taunts.
And Trader3cnd if you have not guessed by now - it is not a formula. It is a process; a process to force your trades to meet your business model of how you want to make or lose money.
An interesting thread - For me risk is at the heart of my business model, so I question your points about position size being a small percent for day traders and larger for swing traders.
I admit that over a very short period risk might be greater as it may be more difficult to establish the nature of the market, for example trends, but after that a longer holding period introduces more risk than a shorter holding period.
So if you have a particular risk profile you wish to adopt within your business model, should you not have smaller position sizes for swing trading and allow larger position sizes for day trading ?
Charlton
The 2% rule was proposed many years ago by position and trend following traders (I think one of them was Ed Seykota) and ONLY for systems with relatively low drawdown levels. For high frequency intraday trading like the example you gave professional traders do not recommend more than 0.25% risk percent calculated based on real-time net equity value. or even less.
Why don't you read a few good books on the subject before trying to reinvent the wheel and show publicly you do not understand the subject.
You are also unaware of the fact that risk percent is an anti-martingale risk management method and as such the actual amount risked decreases as equity decreases.
More advanced risk management methods calculate the risk percent per trade based on a multiple of ATR and an allowable maximum risk.
Quote from superIvan:
What Rabbit needs is a hunting trip
Nothing but a rifle and 3 bullets
frozen night and cold.........bears cougars and packs of wolves
howling in the night as you grip your rifle unable to sleep
What rabbit needs is a chance to be a MAN
he is a WOMAN now?
