Why no more than 3% Equity Risk? [Archive]

View Full Version : Why no more than 3% Equity Risk?

Horst Baum

01-17-2006, 11:42 AM

Hi, Steve!
Please, explain : Why no more than 3% Equity Risk for every trade using the fixed percent risk money management rule?
Surfing on your Forum, it looks like this is a strong truth as I understood!
I'd like to have a "non-empirical" explanation from a trader like you , other than the classical " because all of succesfull traders did not risk statistically more than 3% of their current equity ".
If the only one explanation will be the latest... I'll thank you, however, but I want to understand also why, if it's possible!
I don't want to discuss the trading philosophy ( see www.iitm.com site!). I want only to understand what this your saying is based upon?
I know each one will risk according to his own desire, but... too many successfull traders I heard saying about this " magic3", so that it must be something!
I firmly believe that behing a certain number ( 3% in our case!) is not a magic , but one of the follwing two reasons:
- a statistical behaviour over the history results of the past
or
- a mathematical judgement!
Which of the above two reasons you choose?
Thank you,
Horst

Steve Griffiths

01-17-2006, 11:59 AM

Hi Horst,

I think you have alraedy answered this yourslef in that you have read many many times elswhere, as well as here, that you should not risk more than 2-3% on any single trade.

This is vital as it keeps your losses (when they happen) small. This is the single most important aspect to any succesful trading approach - small lossses and large porfits.

The 2-3% max initial risk is part of this because it always keeps your losses small.

I hope this helps ?

Steve

Horst Baum

01-17-2006, 01:14 PM

Thanks , Steve!
I understood what you meant, but... you actually didn't let me know also the reason why! Why 3%?
The fact that all successfull traders are saying the same could be a strong reason fot this ?
Please, reffer to one of the two possible explanations at the end of my last message!
Thanks,
Horst

grahamek

01-17-2006, 02:01 PM

Maybe it has something to do with a traders win/loss ratio?

Horst Baum

01-17-2006, 02:08 PM

Thanks Sir, but...
I'm waiting a replay from Steve!
Horst

Steve Griffiths

01-17-2006, 02:40 PM

Hi Horst,

You have already had my reply. 2-3% is what I use (and slightly lower for intra-day) and even lower for Stocks (due to the different margin requirements when compaired to Futures).

As you say, this same figure is used by many of the succesful Traders throughout history.

Thanks

Steve

Matt Bowen

01-18-2006, 09:37 AM

Hi Horst,

The answer is very simple...it's called the gambler's fallacy or what I like to call it the "Blow-out Factor" and not many traders adhere to the laws of mathamatical ruin.

Let me give you a quick answer before reading why... If you risk 5% on every trade and you have 8 losses in a row you are down 40% on your account (this does not include slippage and commisions). Now there is something that many traders are not aware of called the "Gain to Recovery" ratio"... this tells how much you need to make JUST TO GET BACK TO EVEN.
If you look at the chart below you can see that a 40% hit will take a 66.7% return just to get the account back to breakeven.I don't know abou you, but I don't like working for free.

Ralph Vince did an experiment with forty Ph.D.s. He ruled out doctorates with a background in statistics or trading. All others were qualified. The forty doctorates were given a computer game to trade. They started with $1,000 and were given 100 trials in a game in which they would win 60% of the time. When they won, they won the amount of money they risked in that trial. When they lost, they lost the amount of money they risked for that trial.

Guess how many of the Ph.Ds had made money at the end of 100 trials? When the results were tabulated, only two of them made money. The other 38 lost money. Imagine that! 95% of them lost money playing a game in which the odds of winning were better than any game in Las Vegas. Why? The reason they lost was their adoption of the gambler's fallacy and the resulting poor money management.

Let's say you started the game risking $1000. In fact, you do that three times in a row and you lose all three times -- a distinct possibility in this game. Now you are down to $7,000 and you think, "I've had three losses in a row, so I'm really due to win now." That's the gambler's fallacy because your chances of winning are still just 60%. Anyway, you decide to bet $3,000 because you are so sure you will win. However, you again lose and now you only have $4,000. Your chances of making money in the game are slim now, because you must make 150% just to break even. Although the chances of four consecutive losses are slim -- .0256 -- it still is quite likely to occur in a 100 trial game.

Here's another way they could have gone broke. Let's say they started out betting $2,500. They have three losses in a row and are now down to $2,500. They now must make 300% just to get back to even and they probably won't do that before they go broke.

In either case, the failure to profit in this easy game occurred because the person risked too much money. The excessive risk occurred for psychological reasons -- greed, the judgmental heuristic of not understanding the odds, or in some cases, the desire to fail. However, mathematically their losses occurred because they were risking too much money.

What typically happens is that the average person comes into most speculative markets with too little money. An account under $50,000 is small, but the average account is only $5,000 to $10,000. As a result, these people are practicing poor money management just because their account is too small. Their mathematical odds of failure are very high just because they open an account that is too small.

Hundreds of thousands of hopefuls open up their speculative accounts yearly, only to be lead to the slaughter by others who are happy to take their money. Many brokers know these people don't have a chance, but they are happy to take their money in the form of fees and commissions. In addition, it takes many $5,000 accounts to feed a single multi-million dollar account that consistently gets a healthy rate of return.

Look at the table below. Notice how much your account has to recover from various sized drawdowns in order to get back to even. For example, losses as large as 20% don't require that much larger of a corresponding gain to get back to even. But a 40% drawdown requires a 66.7% gain to breakeven and a 50% drawdown requires a 100% gain. Losses beyond 50% require huge, improbable gains in order to get back to even. As a result, when you risk too much and lose, your chances of a full recovery are very slim.

Does this mean a trader with a $5000. does not have a chance? No, but you have to remember...at 3% risk per trade they can only risk $150 per trade until they start making money. I guarantee you that most traders trading a $5000. account are risk MORE than $150 per trade and this is exactly what is going to get them into trouble.

Hope that helps,

Horst Baum

01-18-2006, 04:34 PM

Hi, Matt!
Thanks for your answer! However, part of it you just posted in the past here!
Two little corrections and... a question!
The first correction :
At the beginning of your message you said: if you risk 5% of your account and if you have 8 losses in row, you'll have lost finally 40% of your account!
Corrected: If you risked THE SAME QUANTITY, yes, you do!Because 5%x8=40%! But if you risk 5% of the current equity every time , the total loss will be about 33.65% of the initial equity, not 40%. I guess none risk a fixed quantity, but a fixed %!!!
The second : Imagine you apply the fixed risk % as money management. Imagine you'll get 15 losses in row . You'll be at about 46.33% of the initial amount after these 15 losses. Why: simply 0.95x0.95x0.95x...x0.95 ( for 15 times) means exactly 46.33% ( I mean 0.4633).
Now, let's see : How many Risk Units we need to overtake this DrawDown.
One Risk unit gained = 1.05 time the current eqity.
Let's see what means exactly : 2.183 times the current eqity!
Let's join these 16 RU gained to the 15 RU losted: 2.183x.4633=1.01 ( about the initial amount of equity!)
Yhe life it's not so tragic as you said!
Horst

Matt Bowen

01-18-2006, 06:39 PM

Hi Horst,

ou have 8 losses in row, you'll have lost finally 40% of your account!
Corrected: If you risked THE SAME QUANTITY, yes, you do!Because 5%x8=40%!

Correct, I'm not using the position sizing aspect of "decreasing the amount" as the losing streak continued. However, we are talking about the average trader here who is NOT going to adjust the sizing model and we have not factored in commisions and slippage so by the time we do, the portfolio will be closer to -40% rather than to - 33.65% (I would rather side with the worse case here).

The second : Imagine you apply the fixed risk % as money management. Imagine you'll get 15 losses in row . You'll be at about 46.33% of the initial amount after these 15 losses. Why: simply 0.95x0.95x0.95x...x0.95 ( for 15 times) means exactly 46.33% ( I mean 0.4633). Now, let's see : How many Risk Units we need to overtake this DrawDown. Now, let's see : How many Risk Units we need to overtake this DrawDown.
One Risk unit gained = 1.05 time the current eqity.
Let's see what means exactly : 2.183 times the current eqity!
Let's join these 16 RU gained to the 15 RU losted: 2.183x.4633=1.01 ( about the initial amount of equity!)

When you are down 46% on your portfolio, that is a DEEP hole and your not going to climb out of it anytime soon. The point I'm trying to make here is that if the trader gets started by using position sizing then they will not be in this prediciment in the first place.

The bottom line:
You can Risk 1 percent of your capital, you can risk 5 percent, or you can risk 10 percent, but you better realize that the more you risk, the more volatile the results are going to be.

Horst Baum

01-19-2006, 01:21 AM

Thanks, Matt!
But... however, you did'n answer to my question : Why 3%?
Thanks again,
Horst

Horst Baum

01-19-2006, 03:07 AM

Forgive me , Matt, but I must ammend also this your phrase:

You can Risk 1 percent of your capital, you can risk 5 percent, or you can risk 10 percent, but you better realize that the more you risk, the more volatile the results are going to be.
The reason why I must ammend it is this .
Example:
I'll risk 3% of my current Equityfor every trade, and I'll have 1000 trades in a year!
You'll risk on your side let's say 5% , but...you'll have only 100 trades in a year with you system.
Now : It's not use ( I MEAN IT'S OBVIOUSLY!) to assert that basically we'll have the same probability to get a certain let's say 40% Equity DrawDown!!!

So that my ammend to your statement is this: Yes (You can Risk 1 percent of your capital, you can risk 5 percent, or you can risk 10 percent, but you better realize that the more you risk, the more volatile the results are going to be), this is true ONLY for the same number of trades in a year.
Otherwise, see please my example I posted here upstairs!
I don't want here only to "chat", but to learn something more than I know now!
This is the purpose of these my "I don't agree with you!"
Finally, could you give me an " advanced explanation" about why experienced traders risk statistically no more than 3%?
As you saw here, I'm not a newbie but still not an adavnced trader and I'm not a person accepting explanations that every time returns to the basis! We know the basis!
Excuse me , I don't want to hurt you!
I only want a non-empirical explanation about why 3% risk as a " safe risk" over the time and over the experienced traders and this explanation comes itself from an experienced trader(you!)!
Thanks,
Horst

Steve Griffiths

01-19-2006, 05:34 AM

Hi Horst,

I cannot understand why this is such an issue for you.......... You already know that a number of other people suggets this 2-3% figure, so why are you so worried about proving it.

Myself, I do not know of a "study" that proves this number, all I know is that from 20 years experience 2-3% is a good maximum to use. Many porfessional traders use a lot less than this, so the final choice is up to you. All we are saying here is that we do not suggets risking more than this as the probbalility of ruin become too high.

So may I please suggets that you just accecpt that this is a good figure to use, but the final choice is up to you. We have nothing more to add to this..... Time to move on now.

Steve

jswin

01-19-2006, 10:38 AM

Hi Horst, it seems odd that for a man with an obvious interest in statistics, you're seeking to extract an answer based on the supernatural - or at the very least, a phenomonen.
I know it is not as interesting, but have you considered that perhaps the 3% figure is based on a reasonable drawdown that is relatively easily fought back and does not require too much 'free work' as Matt mentioned.
Sorry Horst (or was it Marcus?), but you won't find the code to any lost treasure mapped in the 3% I am guessing.

Matt Bowen

01-19-2006, 10:38 AM

Hi Horst,

You need to read the book...http://www.iitm.com/products/books/trade_your_way_to_financial_free.htm

One of the best MTPredcitor traders called me this morning and he thank me for having reminded him to read this book. He said this was one of the best books he's ever read on trading...I happen to agree with him.

By taking the time to read this book you will not only get your answer on the 3%, but you will come away a much more educated trader.

Best regards,

jswin

01-19-2006, 10:48 AM

Horst, the author Matt mentions also has a trading game which gives you a feel for dradowns etc and puts the R/R ratio into context as you watch your equity move in front of your eyes. You'll witness first-hand the benefits of low-risk trading in a mathematically sound simulator.
It helped me anyway.

Matt Bowen

01-19-2006, 11:20 AM

Hi Jswin,

I agree...the "Secrets of the Masters" game is probably the best way to learn the position Sizing. I will post the Interoduction of the game here with a plug for Van Tharp on where they can download it from his site. He offers the first three levels for free.

Thanks for the reminder,

-Matt

Matt Bowen

01-19-2006, 11:26 AM

Introduction to Position Sizing™: The Secrets of the Masters Trading Game
By Van K. Tharp, Ph.D.

Part-1

Background:

People are always looking for the "real" secrets of trading success, but their mental biases always have them looking in the wrong places and at the wrong things. Consequently, they search for magical trading systems with 75% accuracy or better or for great entry systems that they think will help them pick the right stock. Picking the right stock has nothing to do with success and neither does the accuracy of your stock picking.

You might be saying, "How can you say that?" Well, practically all Market Wizards agree that the key ingredients to your success are (1) the golden rule of trading - "cut your losses short and let your profits run;" (2) position sizing™ or that part of your trading system that tells you how much; and (3) the discipline to do both. When you think about the golden rule of trading, it basically describes exits - how you abort losses and ride winners. When you think about position sizing™, it basically controls how much you risk on any given trade.

I've designed Position Sizing™: The Secrets of the Masters Trading Game to help you learn the secrets to trading success before you play the markets. This game totally de-emphasizes entry or "stock picking" and instead requires that you focus on the most important aspects of trading - position sizing™ and letting your profits run. Our game has ten levels that get progressively more difficult to master. However, once you've mastered these principles, you'll know you've mastered some of the key skills to trading success.

To complete this game, you must master four key principles. These principles include (1) understanding the importance of R-multiples; (2) understanding the difference between expectancy and probability; (3) learning how to let profits run without letting them escape; and (4) using position sizing™ to make sure you have a low-risk trade. The Position Sizing™: The Secrets of the Masters Trading Game is designed to drive these principles home by giving you the experience of making (or losing) money in a game environment where losing is safer.

R-Multiples: First, you must understand the principle of R-multiples. R stands for risk, the risk you take on any trade when you enter the market. It reflects that point at which you plan to get out in order to preserve your capital. For example, if you buy a stock at $50 and you plan to get out if it drops to $47 or below, then your R value in this trade is $3.00 (i.e., $50 minus $47 = $3.00).

You want your losses to be small (i.e., an R-multiple of one or less) and your profits to be large R-multiples (2 or more). Losses can be bigger than 1R, when the market gaps against you and goes through your "get me out" point. Then can also be bigger than 1R when you make a psychological mistake and fail to get out when your stop point is reached. Excessive costs (commissions and slippage) can also result in big losing R-multiples.

This game is not necessarily like the movement of various stocks in the market. Instead, it is like running a trading system that has certain characteristics.

When you let your profits run, then you want your profits to be much bigger than 1R. For example, if R is $3 (as it was in our example above), then a $15 profit is a 5R profit. Now suppose you have a trading system in which you are right 25% of the time. When you win, you make 5R (i.e., in our example $15). When you lose, you lose 1R or $3. In our example with your system that is right one time (i.e., a $15 gain) for every three losses of $3 each (i.e., a total of $9 in losses), you still make a profit of $6. Imagine that! You are right 25% of the time and you still make money. That's why the principle of cutting your losses short (i.e., so you will have small R-multiple losses) and letting your profits run (i.e., so you will have big R-multiple gains) is so important. You still make money, even when you only make money on 25% of your trades.

The first level of Position Sizing™: The Secrets of the Masters Trading Game teaches you position sizing™ and the importance of large R-multiples. What you win or lose will be expressed as R-multiples and these values are described in the level instructions for each level and are also viewable in the statistics window while playing the simulation. Thus, a loss of 1 times what you risk is a 1R loss. A loss of 5 times what you risk is a 5R loss. Similarly, a gain of 1 times what you risk is a 1R gain. A gain of 10 times what you risk is a 10R gain.

In level one, for example, sixty percent of your trades (on the average) will be winners. Most of them (55% of all trades on the average) will be 1R gains. Thus, on 55% of your trades, you'll win whatever you risk. If you risk $1,000, then you will win $1,000 on a 1R gain. In level one, 5% of all trades will be 10R gains. In other words, if you risk $1,000 when one of these trades come along, you'll make ten times what you risked or $10,000. It's simple and easy. However, 35% of your trades in level one will be 1R losers and 5% of your trades will be 5R losers. Hopefully, you'll get a chance to learn the psychological agony of having a 5-R trade go against you in this level.

Notice how level one has probability on your side (60% winners) and the big R-multiple winners as well. That is, you have the potential of a 10-R winner in your favor. That won't be the case in the future levels. As a result, it brings up our next topic - expectancy.

Matt Bowen

01-19-2006, 11:28 AM

Part-2

Expectancy Versus Probability: Expectancy is a mathematical formula that tells you how much you will win on the average per dollar risked. It takes into account both the probability of winning (or losing) and the size of the R-multiples. Casino gambling games are all negative expectancy games - you cannot make money in the long run unless you can do something to change the odds. In trading, you must play a different game from gambling. You must have a positive expectancy game on your side in order to make money in the long run.

Most people make a mistake by looking for games (or trading systems) that make them right. However, such games can have a negative expectancy (meaning that you'll lose money overall) if some of the losers have large R-multiples. More importantly, some of the best trading ideas have large R-multiples in your favor, but only make money 25-40% of the time.

Let's look at an example. Suppose you buy a stock and plan to get out when it drops against you by a dollar. For example, if you buy a $50 stock, you'll get out when it drops to $49. However, when you are right you expect that stock to move 30%. In the case of our $50 stock, a 30% move is an additional $15. Now think about this situation. When you are wrong, you lose one dollar per share! When you are right, you make $15 per share. What if you were only right 30% of the time - you make money in three of ten trades. Thus, in ten trades you'd make $15 per share an average of three times. Your total gain would be $45 per share. In the same ten trades, you'd lose $1 per share on the average seven times. Your total loss would be $7 per share. Thus, over the ten trades you'd end up making $38 per share - even though you were only right 30% of the time. Large R-multiples in your favor are much more significant than "being right" in the equation for making money in the market. Remember that!

The reason you will have made so much money is because of your exits. Your exits gave you a trading method that had a very high positive expectancy. So let's explore this concept of expectancy a little more thoroughly.

Basically, when you calculate expectancy you will multiply each R-multiple (both negative and positive) by its probability of occurrence. You then sum the results (i.e., subtracting the values of the negative R-multiples) to get the total expectancy. All of the probabilities, of course, must add up to 100%. If not, it means that you have missed some. In the case of our stock example, you multiply 0.3 times 15, which is 4.5, and 0.7 times minus 1, which is minus 0.7. When you add 4.5 and minus 0.7, you have a total expectancy of 3.8. This means that you will average in gains, over many trades, 3.8 times your risk on each trade. You can also calculate expectancy by simply adding up the R-multiples (with winning being positive numbers and losing being negative numbers) and then dividing that sum by the total number of trades.

While the calculation of expectancy might seem complicated to some of you, we have good news. The game will calculate the expectancy for you. You can find the expectancy of each level in the statistics window. You'll also know what the probability is of each trade. Since the trades are random, you could easily get 10 losers in a row and that won't follow the expectancy. However, at the end of the level, you'll probably be pretty close to the expectancy of that level. It's just like real trading in that you won't know whether the next trade will be a winner or not. However, to help you the game will also give you the expectancy of the trades to date as they are randomly picked. Thus, you will know how far the trades are off from the likely expectancy that was built into the game.

There is a critical aspect to expectancy that you must understand. Expectancy and probability are not necessarily the same. As I said earlier, you must have expectancy on your side, but you don't need to have probability on your side. Let's look at the simple stock market example given earlier. You win 30% of the time, but when you win it's a 5-R gain. You lose 70% of the time, but when you lose it's a 1-R. You only make money 30% of the time. Thus, the odds are against you. However, the game has a positive expectancy - giving you an average of 3.8 times your risk each trade.

Probability and expectancy will be separate in every level after level two. This is a more advanced trading concept for you to master. Beginning with level five, you'll even have the option of going with the probability (i.e., winning most of the time) or going with the expectancy. Hopefully, you'll learn how dangerous it is to bet against the expectancy, even though you get to win (or be right) more often.

Letting Your Profits Run: In the first six levels, getting a big R-multiple will be easy. If you hit one, you get the big win. If you hit a 10R multiple, you will win 10 times what you risk.

In the last four levels, you'll have to earn your big R-multiples by letting your profits run - just like in real trading. Losing trades will happen quickly, but winning trades will take time to develop. When a winning trade starts, it will probably just be a 1R win. You now have to wait another day (i.e., in the case of the game, trade) to determine if it will continue and how much of your gain you want to risk. When a winning streak starts, the chances of it continuing are good. However, you'll need to decide if you want to risk it all or just a portion of your profits.

For example, here's the start of a winning streak:

Joe's Foods, Inc. Risk $1,000 Won $1,000 Amount At Stake $2,000
Do you want to risk the entire $2,000 or not? Let's say you do and you again have a 1:1 winner. Here is your situation:

Joe's Foods, Inc. Risk $2,000 Won $2,000 Amount At Stake $4,000

You now have a 3R gain (i.e., your initial risk plus another 3R). Do you risk it all or just a portion of it? If you risk it all, you could allow a substantial gain to turn into a loss. Risking a portion of it is the equivalent to moving up your stop loss point in real trading. You decide to risk it all one more time. Fortunately, you win and your new situation is as follows:

Joe's Foods, Inc. Risk $4,000 Won $4,000 Amount At Stake $8,000

You now have a 7R gain (i.e., your initial risk plus another 7R). If you risk it all, you'll have a huge profit if you win. On the other had, you could get a 3R or 4R loser. If that happens, your loss would be huge. As a result, you decide to cut your risk back to $2,000. You now wait for the next day's activities to occur. Again, you win:

Joe's Foods, Inc. Risk $2,000 Won $2,000 Winnings $10,000

You can now risk any portion of that $10,000 or all of it. You already have a 9R profit on this trade, based on your original $1,000 risk. Do you now understand how letting your profits run can produce big R-multiple gains? The seventh level you play will require that you master the secret of letting your profits run in order to make much money.

Using Position Sizing™ (i.e., how much you risk) so that you have a low risk idea: Imagine that you are playing the first level, which you will be doing shortly. You have $10,000 in equity. You know that sixty percent of your trades, on the average, will be winners. You also know that there is a 10R gain someplace in your future. You decide to risk $2,000 or 20% of your equity. The first trade occurs and it ends up being the 5R loser. You've lost five times your bet of $2,000 or $10,000. That was your entire stake and you are now bankrupt. Thus, you risked too much, despite having both expectancy and probability in your favor. You went bankrupt.

In any positive expectancy game, there is a percentage of your equity that will give you an optimum return. That optimum percentage will give you the maximum rate of return over time. It will also give terrible drawdowns. Lower percentages of risk will give you less return and smaller drawdowns. And if you risk too much, you risk bankruptcy.

Thus, my definition of a low risk idea is:

"an idea with a positive expectancy that is traded at a risk level that will allow you to survive in the short term, so that you can achieve the positive expectancy over the long term."

At each level, you will have to study the situation thoroughly to decide how much you want to risk on each trade. One of the main lessons you must master in order to profit will be the art of position sizing™. You can think about various strategies, such as playing the markets money or fixed ratio trading, and try them out without risking real money. In addition, you can purchase our reports on money management and position sizing™ and learn about ideas that you may never have considered. Call 919-852-3994 for more details.

The objective of the overall game is to safely complete all ten levels without going bankrupt, while making as much as you can.

Now go to the "File" menu and choose "New Simulation…" In the window that appears, make sure "Standard Game" is selected and then press the "OK" button. This will begin the simulation and display the instructions for the first level. The object of this level is to make at least 50% within 75 trials, allowing you to move to the next level. In each level, you'll automatically advance if you increase your equity by five times.

Much success and may you learn a great deal from this game!

Van K. Tharp, Ph.D.
http://www.iitm.com/

You can download the Game here: http://www.iitm.com/regform.asp

(The first three levels are free... but after level 6 you are really put to the test)

jswin

02-02-2006, 07:27 PM

Hey there Matt,

When trading MTP EOD, should the 2% risk factor be based on the available margin in my account after that evening's scan - before the following day when trades are potentially triggered?
My concern is that let's say I placed 5 orders for the following day. The next day comes along and an order is triggered. My available margin decreases accordingly. If another trade is triggered, will the risk to my account actually have increased to greater than 2% because there is less available margin?
Or should the risk be based on the entire account size irrespective of current margin commitments?
Should position size always be adjusted to the available margin at the time the trade is triggered or, if my account was $50,000 one evening, should all trades (opening orders) be based on a risk of $1000 for the following day only.
Cheers
Joel

mrkam

02-03-2006, 01:29 PM

Hi experts....

I am doing the Trading Game and found a problem?? maybe.... We are given the share cost, and we then input number of shares and risk per share for the trade. Then, after we "trade". The game tells us the R multiple win/loss after the trade. The problem I saw was that the game gives you the big multiple R loss, even though in "real" life, we would have limited the loss. That is, with MTP, we set out postition to risk, say 2%. Say that 2% is $200. So the stock goes down, we stop out, and we lose the $200. No problem. But, the game does not limit the loss. It came back to me with the rare 5R loss, and dinged me for the $1,000. But this isn't accurate, is it?? Now, I know that even at this 5R loss, it is limited because I limited my trade to 20% max account and 2% risk, but, the 2% risk isn't really right, because the game does not limit to that risk, but gives you the loss at whatever R mulitple it wants to give you??

Anyway, just an observation.

Also, I don't really see the "challenge" in this. For every trade, just limit the total trade to max 20% of account, and max 2% risk. No consideration to cost per share, spread, etc..... just do the two calcs (actually, the game does it for you, just change the numbers to get your 20%/2%). So it really is a monkey game. Same process for every trade... Just keep plugging the numbers, and the account will grow, (with positive expectancy, which is already built into the game...)

Anyway, any thoughts??

stevej

02-03-2006, 02:28 PM

Gaps happen!

Matt Bowen

02-07-2006, 10:02 AM

Hi mrkam,

What level are you at in the game? The serious test will come in at level 7, 8 and 9. The first 6 levels are designed to get the trader used to placing orders based on position sizing and not getting cute and trying to screw with the system (which almost all traders do)....that's why you find it so boring. Nobody said trading was exciting, in fact, if you are excited when you are trading then I can tell you something is wrong. Trading is very disciplined, methodical and boring.

I find that when people are excited about trading it's usually because they are trying to control the market with their latest "GIZMO" (new software trading tools).

But, the game does not limit the loss. It came back to me with the rare 5R loss, and dinged me for the $1,000. But this isn't accurate, is it?? Now, I know that even at this 5R loss, it is limited because I limited my trade to 20% max account and 2% risk, but, the 2% risk isn't really right, because the game does not limit to that risk, but gives you the loss at whatever R mulitple it wants to give you??

It's like Stevej just told you...gaps do happen. I've had it happen to me and it just part of the business. Also, a string of stops that can trigger at lower prices can also have a similar effect.

Also, I don't really see the "challenge" in this. For every trade, just limit the total trade to max 20% of account, and max 2% risk. No consideration to cost per share, spread, etc..... just do the two calcs (actually, the game does it for you, just change the numbers to get your 20%/2%).

What do you think I do in my own trading? I run the risk metrics everytime, I don't care what the price is...if the spread (volatility) is to wide then the risk will be greater than the what my 2% per trade allows. Why do you think I have this posted on my newsletter:

http://www.mtptrader.com/PS2.gif

mrkam, you are trying to control the game... let me give you a piece of advice, you can't control the market, you can only control the risk.

All the best,

mrkam

02-07-2006, 10:23 AM

Cool, and thanks. Just wanted to make sure I wasn't missing something in the game. Actually, I am trying NOT to control anthing, EXCEPT the risk amount per trade. Period. My perception of the game was that risk was the ONLY thing we are really allowed to play with, and the point was NOT to "play" with it, but treat every trade the same at X% risk for X% total equity.... so, thanks for the confirmation.

Oh, and I like boring. Boring is good. The "excitement" of the trade will turn is into idiots...

OK on the gaps, if that is the intent of the game. Just seemed like gaps could be a modeled with a little more sophistication, but hey, if this works!

Oh, and I am not at the higher levels..... just a few early observations..

I simply wanted to see if I was missing anything in the game.. Sorry if it came off otherwise... It seems as if the game is designed specifically and exclusively for learning risk/position management. If I took every trade it gave me at a consistent, low risk, and kept the total % of equity per trade at a reasonable (low, say <20%) level, then one would be successful.

I like that!

Matt Bowen

02-07-2006, 10:46 AM

Hi mrkam,

Ok, I saw the note was posted a few days a ago. I like to check back every few days to make sure the threads are updated.

Yes, I figured you would get the hang of it over a few days of working with the game. I think the game is good because it hammers in the position sizing and after you start to get to the higher levels (above level 5) you really have to understand what you are doing because now the automatic controls are removed. This is where your equity curve can turn into a real "yo-yo" if you don't understand the material. It's kind of cool because, somebody can sit there and shake their head in agreement and say: "yeah, sure I understand the material, but then when you look at their equity curve on level 7, 8 and 9 it's very obvious that they DON'T understand the material because their equity curve is all over the place. It's like a price chart: "Charts don't lie" they only tell the facts.

In any case, I'm glad you picked it up and now it's very clear.

All the best,

34107

04-23-2006, 10:40 AM

AndyvB

04-23-2006, 12:32 PM

Your risk is based on the account equity.

Matt Bowen

04-24-2006, 10:05 AM

Hi 34107,

This link should help answer that question:

http://www.iitm.com/tips/Tips-MM.htm

Hope that helps,

jswin

04-24-2006, 06:44 PM

Hi Matt, I posted the original question 34107 is referring to... I read through Van Tharp's article again but could not find a clear-cut answer.
With regard to how you personally ascertain position size on an EOD basis - would you base your 2% per trade on the total amount of equity in your account on a particular night after scanning (for each of multiple orders the next day)? Or once one order had been filled the next day whose position size was based on the full account equity from the previous day (assuming no positions were open), would your second order have its position size based on 2% of available margin taking into account the reduction caused by the first trade being filled?

Thanks
Joel

Matt Bowen

04-24-2006, 07:27 PM

My concern is that let's say I placed 5 orders for the following day. The next day comes along and an order is triggered. My available margin decreases accordingly. If another trade is triggered, will the risk to my account actually have increased to greater than 2% because there is less available margin?

Excellent Question:
We had an earlier discussion on this topic: http://www.mtptrader.com/showthread.php?t=331

Also keep in mind you might have on 5 winning positions that would also increase the available margin.

You can do it several ways... all based on risk tolerance and more specifically what's allowed by your brokers...not all brokers use the same margin rules.

One way might be based on available margin. Another might be based on available equity and possibly another might be base on equity/margin percentage exposure (this can be implemented by the broker or if it's hedge fund the risk department may have set guidelines.

The simplest way is to take available equity (some brokers do not allow this due to their margin requirements). It really depends on what the broker will allow you to do...this is something most people do not ask because they are not using risk management ;)

jswin

04-25-2006, 11:30 AM

It really depends on what the broker will allow you to do...this is something most people do not ask because they are not using risk management ;)

Hi Matt,
Thanks for the reply. In my case, the broker is not quite so important. I am self-trading CFDs in the UK. The day after my EOD MTP scan, I choose what size trade to place. When the market opens, I really just need to know whether I should place my five hypothetical orders and for each have a position size of 2% based on the available margin in my account the previous evening. Or should I take the much more laborious approach of calculating the 2% for each potential position based on 2% of available margin as each new position is filled.
Cheers

Matt Bowen

04-25-2006, 12:38 PM

Hi Jswin,

I would like to help you, but here in the U.S. we can't do CFD's so you might have Tony or Steve in the London office help you with this one. I don't know anything about CFD's so I'm the wrong person to ask. I'm sure Steve or Tony will jump in here for a follow-up.

All the best,

mrkam

04-25-2006, 08:51 PM

Hi Jswin,

I know your question exactly, and here is what I have come to. I think the overall point in the 2% risk "guideline" is to limit your drawdowns so you can live to trade another day when taking an (almost) certain "bad" streak at some point in our careers. At the same time, have enough to make a significant amout as you let the winners run. So, to do that, risk 1-3%. Some MTP folks I know risk up to 5%, all depending on your risk tolerance, and resources!! Personally, I am at 1.5% for now.

So, understanding the general purpose of the exercise, I figure somewhere "around" 2% is OK fine for limiting your drawdowns. So, in your case, I would set all 5 up at 2% of my aggregate trading account that evening. Easy, done deal. Then manage as you go. If you take all 5, and all 5 are losers, then reset for your next trades. But, as Matt alluded to, more than likely, you will get some winners along the way, so probably, all will be fine. Or, if you take one or two, then you want to adjust your pending trades, then do that. All part of management, I figure. The main thing is don't get yourself into a "fixed risk amount" scenerio where after 6 or 8 losers you are now risking 6,8,10% to get yourself back!! See ya!! fun while it lasted...

And I also don't (can't) trade CFDs, so I have no idea how that affects this concept. My guess is not at all.

Hope that helps....

jswin

04-26-2006, 06:59 AM