This subject is so important, I stole it
Posted on | Thursday, March 25, 2010 | 1 Comment
Discretionary Traders Number One Enemy
and
Many Traders Do Not Know About It.
"A trading system alone will not assure success without proper risk control, beginning with individual trades, extending to diversification of markets, and continuing until a portfolio of different trading strategies is created. Every trading style has losing streaks that will ruin an investor who begins trading at the wrong time without adequate capital; therefore the size of the position, the markets to trade, and when to increase or decrease leverage become important for financial survival." by Perry J. Kaufman
This image shows trading account drawdown percentages and what percentage gain is required to return your trading account back to the amount prior to the drawdown.
What percentage drawdown are you willing to have in your trading ?
Want smaller drawdowns ? - read on.
Learning risk control from a Coin Toss example
Simply because a coin only has two outcomes - heads or tails,
everybody knows the odds of a coin toss is 50 / 50.
With large numbers of Coin Tosses, results match the theoretical 50 / 50 outcome.
But most Traders commonly fall right into the Risk Trap of thinking each coin toss
will tend to alternate from heads to tails and then back to heads again.
Reality proves this only happens about 30% of the time.
So what happens the other 70% of the time ?
Exploring the Reality for an Actual 100 Coin Toss Exercise
Take out a coin,
On paper number from 1 -100
Make 100 actual coin tosses.
Recording each of the 100 coin tosses as Heads or Tails.
These next three images are a real recorded 100 coin toss event
Page1
Page 2
Page 3
The ACTUAL results showed a 14% spread instead of the expected 50 / 50 split.
This next image shows the long lossing streaks that occurred in this ACTUAL coin toss sample
The next image is critical to understand trading risk, it shows the trading account drawdown percentage that results from lossing streaks using different percentage of account equity at risk per trade and the single critical element you must control is what percentage of account equity you risk on each trade you take. That is a most important aspect to your trading success.
Traders the important part to understand from this posting is every strategy WILL have lossing streaks that most likely will be bigger than you might think. If you risk too big of a percent of equity on each trade you make your guaranteed given enough time trading to hit the Risk of Ruin event (in other words -> your account being busted).
I would not presume to suggest what another trader should risk. I do suggest to trade from an informed stand point of the relationships between position sizing, account equity at risk per trade and drawdowns. What I am saying it this posting is pick the maximum drawdown percentage your willing to suffer. Look at your strategies consecutive lossing steaks increase that by a safety margin and then use the chart to pick the percentage account equity at risk that will keep you under the drawdown level YOU have chosen.
Number One Worst Enemy Of Traders
Uncontrolled Risk from making large equity risking trades. Trading is not swinging for the fence home run while racking up a long string of strike outs. Controlling risk is the only way to stay in the trading game for the long haul.
Critical Key to Successful & Long Term Profitable Trading
Taking a profit from a very large number of extremely small percentage of equity risking trades. Keeping you account equity at risk per trade in the range from 1/2% to max of 3% . This equity at risk percentage per trade is not talking about the margin/buying power used to get in the trade it is the amount at equity at risk before your trade position hit your stoploss. If you do not have a very clearly defined stoploss on every trade, then look out your headed toward experience a Risk of Ruin experience.
Bottomline
1- Pick the maximum drawdown percentage your willing to suffer.
2- Look at your strategies consecutive loses then increase that number by a safety margin.
3- Next use the chart to pick the percentage account equity at risk that will keep you under the drawdown level YOU have chosen.
Low Risk Trading Strategy (from Van Tharp)
A Low Risk trading strategy is a strategy with a long-term positive expectancy that's traded at a equity percentage risk level to allow for the worst possible occurrence in the short term without the Risk of Ruin drawdown so that you are able to realize the long-term positive expectancy / profits from your strategy.
and
Many Traders Do Not Know About It.
"A trading system alone will not assure success without proper risk control, beginning with individual trades, extending to diversification of markets, and continuing until a portfolio of different trading strategies is created. Every trading style has losing streaks that will ruin an investor who begins trading at the wrong time without adequate capital; therefore the size of the position, the markets to trade, and when to increase or decrease leverage become important for financial survival." by Perry J. Kaufman
This image shows trading account drawdown percentages and what percentage gain is required to return your trading account back to the amount prior to the drawdown.
What percentage drawdown are you willing to have in your trading ?
Want smaller drawdowns ? - read on.
Learning risk control from a Coin Toss example
Simply because a coin only has two outcomes - heads or tails,
everybody knows the odds of a coin toss is 50 / 50.
With large numbers of Coin Tosses, results match the theoretical 50 / 50 outcome.
But most Traders commonly fall right into the Risk Trap of thinking each coin toss
will tend to alternate from heads to tails and then back to heads again.
Reality proves this only happens about 30% of the time.
So what happens the other 70% of the time ?
Exploring the Reality for an Actual 100 Coin Toss Exercise
Take out a coin,
On paper number from 1 -100
Make 100 actual coin tosses.
Recording each of the 100 coin tosses as Heads or Tails.
These next three images are a real recorded 100 coin toss event
Page1
Page 2
Page 3
The ACTUAL results showed a 14% spread instead of the expected 50 / 50 split.
This next image shows the long lossing streaks that occurred in this ACTUAL coin toss sample
The next image is critical to understand trading risk, it shows the trading account drawdown percentage that results from lossing streaks using different percentage of account equity at risk per trade and the single critical element you must control is what percentage of account equity you risk on each trade you take. That is a most important aspect to your trading success.
Traders the important part to understand from this posting is every strategy WILL have lossing streaks that most likely will be bigger than you might think. If you risk too big of a percent of equity on each trade you make your guaranteed given enough time trading to hit the Risk of Ruin event (in other words -> your account being busted).
I would not presume to suggest what another trader should risk. I do suggest to trade from an informed stand point of the relationships between position sizing, account equity at risk per trade and drawdowns. What I am saying it this posting is pick the maximum drawdown percentage your willing to suffer. Look at your strategies consecutive lossing steaks increase that by a safety margin and then use the chart to pick the percentage account equity at risk that will keep you under the drawdown level YOU have chosen.
Number One Worst Enemy Of Traders
Uncontrolled Risk from making large equity risking trades. Trading is not swinging for the fence home run while racking up a long string of strike outs. Controlling risk is the only way to stay in the trading game for the long haul.
Critical Key to Successful & Long Term Profitable Trading
Taking a profit from a very large number of extremely small percentage of equity risking trades. Keeping you account equity at risk per trade in the range from 1/2% to max of 3% . This equity at risk percentage per trade is not talking about the margin/buying power used to get in the trade it is the amount at equity at risk before your trade position hit your stoploss. If you do not have a very clearly defined stoploss on every trade, then look out your headed toward experience a Risk of Ruin experience.
Bottomline
1- Pick the maximum drawdown percentage your willing to suffer.
2- Look at your strategies consecutive loses then increase that number by a safety margin.
3- Next use the chart to pick the percentage account equity at risk that will keep you under the drawdown level YOU have chosen.
Low Risk Trading Strategy (from Van Tharp)
A Low Risk trading strategy is a strategy with a long-term positive expectancy that's traded at a equity percentage risk level to allow for the worst possible occurrence in the short term without the Risk of Ruin drawdown so that you are able to realize the long-term positive expectancy / profits from your strategy.
Comments
March 31, 2010 at 8:31 PM
Dr. Van Tharp has devised a trading strategy that will help you to reduce your losses and increase the profits. He says that all good trading methods are 60% psychological, 30% money management and 10% trading system.