Prudent Risk Management Is The Only True Edge In TRADING

[tiddlywinks]

in your response you overtly use the word risk. This is all we can control----risk.

Agree. But minimizing losses AND maximizing profits is NOT EXPECTANCY, which YOU stated is CREATED by PRM.

Expectancy is calculated from those losses and gains, regardless of whether the losses are minimized or the gains are maximized.

 

[taowave]

so,by your definition,you can take a system.discretionary or not,positive expectancy or not and make it profitable by letting profits run and cutting losses....

Good luck with that

But in your response you overtly use the word risk. This is all we can control----risk. PRM is not just about cutting losses, it is also about maximizing wins. This is the only True Edge in trading.

 

[ironchef]

I decided to dig up studies I did a few years ago when I was working pn my option trading strategy. One of which is a paper by Kelly on the Kelly Criteria. He developed the Kelly Criteria, proved mathematically that the risk of ruin could be minimized in a bet by limiting the bet size to < Kelly Criteria.

Stripping out all the fancy mathematics, it is basically @Buy1Sell2's PRM. However, Kelly also showed that if there is no positive expectancy, all Kelly Criteria can do for you is you go broke slowly.

 

[taowave]

Kelly is great,if you can somewhat accurately predict the probability distribution in advance...
If that were so easy,there would be a ton of very rich vol traders....

Proper risk management is obviously a key element of successful trading,but its no easy task,and certainly not the only edge...IMHO,the real edge with PRM is to estimate probability distributions somewhat accurately and hence position size accordingly with appropriate R/R ratios..

I decided to dig up studies I did a few years ago when I was working pn my option trading strategy. One of which is a paper by Kelly on the Kelly Criteria. He developed the Kelly Criteria, proved mathematically that the risk of ruin could be minimized in a bet by limiting the bet size to < Kelly Criteria.

Stripping out all the fancy mathematics, it is basically @Buy1Sell2's PRM. However, Kelly also showed that if there is no positive expectancy, all Kelly Criteria can do for you is you go broke slowly.

 

[ironchef]

Kelly is great,if you can somewhat accurately predict the probability distribution in advance...
If that were so easy,there would be a ton of very rich vol traders....

Proper risk management is obviously a key element of successful trading,but its no easy task,and certainly not the only edge...IMHO,the real edge with PRM is to estimate probability distributions somewhat accurately and hence position size accordingly with appropriate R/R ratios..

Yes sir. Unfortunately most expectancy cannot be predicted in advance, that is why folks trade with fraction Kelly Criteria as a margin of safety.

Kelly is tied to expectancy and often, it is difficult to calculate expectancy without accumulating a large database, especially if your strategy is evolving.

I do have sufficient data in my option trades to establish expectancy but as the market evolves, it changes my expectancy and I have to make adjustments.

 

[Jzwu2017]

However, Kelly also showed that if there is no positive expectancy, all Kelly Criteria can do for you is you go broke slowly.

So this is exactly what happens in Las Vegas casinos. We know that the betting statistics is against gamblers so the expectancy is negative. You go broke by keeping gambling.

However, in the stock market I am not sure about the expectancy. If the expectancy is Not negative, e.g., random, one may win by gambling according to the Kelly criteria? So Buy1Sell2 may be indeed right about PRM?

 

[Buy1Sell2]

So this is exactly what happens in Las Vegas casinos. We know that the betting statistics is against gamblers so the expectancy is negative. You go broke by keeping gambling.

However, in the stock market I am not sure about the expectancy. If the expectancy is Not negative, e.g., random, one may win by gambling according to the Kelly criteria? So Buy1Sell2 may be indeed right about PRM?

Correct. Even with a low win rate, positive expectancy occurs due to proper utilization of PRM. Most traders do not utilize PRM. ---

 

[ironchef]

So this is exactly what happens in Las Vegas casinos. We know that the betting statistics is against gamblers so the expectancy is negative. You go broke by keeping gambling.

However, in the stock market I am not sure about the expectancy. If the expectancy is Not negative, e.g., random, one may win by gambling according to the Kelly criteria? So Buy1Sell2 may be indeed right about PRM?

If the market is random, averages to zero (BE), like a coin flip, slippages like bid/ask and timing, etc. will mean the expectancy is negative, just like Vegas. So PRM, like Kelly is a slower road to ruin.

Fortunately, market is not random (just look at the tails, most are not normally distributed), so there is hope.

But as I said before, I don't think I can make money trading options or day trade stocks without practicing PRM.

 

[themickey]

If the market is random, averages to zero (BE), like a coin flip, slippages like bid/ask and timing, etc. will mean the expectancy is negative, just like Vegas. So PRM, like Kelly is a slower road to ruin.

Fortunately, market is not random (just look at the tails, most are not normally distributed), so there is hope.

Imo, the shorter the time frame their is higher degrees of randomness.
Say for example a stock or market wants to travel $1.00.
To get there on a minute by minute time frame, it will zigzag a huge amount, jumping up and down mostly unpredictably.
If you view the same period on a monthly bars time frame for example, there will be maybe 1-2 bars which are in trend with previous monthly bars and appear non random.

Those who say every tick is planned and not random, are talking religous destiny bollocks where "not one sparrow falls to the ground...... " blah blah bs.

 

[ironchef]

Imo, the shorter the time frame their is higher degrees of randomness.
Say for example a stock or market wants to travel $1.00.
To get there on a minute by minute time frame, it will zigzag a huge amount, jumping up and down mostly unpredictably.
If you view the same period on a monthly bars time frame for example, there will be maybe 1-2 bars which are in trend with previous monthly bars and appear non random.

Those who say every tick is planned and not random, are talking religous destiny bollocks where "not one sparrow falls to the ground...... " blah blah bs.

It is true @themickey, in theory, noise grows as square root of time, so shorter time frame should appear more noisy, relatively speaking.

Also, most stocks have a drift term (growth) but in day trading, it is completely masked by short term noise whereas if you wait long enough, it will definitely show up and overwhelm the noises, why long term buy and hold actually works.

It is a good question why I chose to day trade with minute chart? I don't know why.

Regards,