A Different Approach.....

[bootstrap 47]

The idea for this post came out of an email I recently sent to a struggling trader.

 

And with the loonies still running amuk in the street, there is no time like the present. So here goes.

 

Are you struggling with your strategy development? Have you hit that wall where no matter what you do, you just can't quite make it work? Well take a step back and look at what you are doing from a different perspective.

 

If you accept the often quoted stat that 95% of all traders fail and eventually give up, the the secret is to do the exact opposite of what the herd is doing. Sounds simple enough.

 

When a newbie first starts out, he jumps from one strategy/indicator to the next. Looking for that secret. Well if the indicator is truly an integral part of the secret, why in the hell do I have a library full of them?

 

They spend countless hours on testing, back-testing, and tweaking. Then just use simple exits and risk management.

 

But you have to have a way to get in the market.

 

So I am going to break that cardinal trader rule and fast track you over to the path.

 

Currently you are on the path of: Setup - Entry - Exits - Position Size - Money Management.

 

Well, the real traders have been telling you that Money is key. You have to protect your capital. You have to be adequately funded. That you need follow the KISS principle. They have been giving you the path, but you haven't been listening.

 

There is nothing wrong with the Set-up to Money path, but you better have the capital to trade what you find. As you move from Set-up to Risk Management you need to put as much if not more thought into each step. The 95% spend months on set-up and entry, and then less and less time as they move through the steps.

 

But what you really need is to find that strategy that will work with the capital you do have. And build around the premise that you will live to fight another day.

 

So reverse the development steps. Start with Money/Risk Management and work backwards to the Set-up. Take the strategy that you are currently working on right now. Dissect into the individual parts. Then start with Risk management and develop that first. While doing this ignore what you have done on the next step down. Just concentrate on managing your risk.

 

Work back through your strategy to the Set-up.

 

Are your exits the same? Is the position size the same? What about entry? Do you really need all those indicators now?

 

You may just be surprsied at what you find.

[zdo 20]

bootstrap,

 

Lately the 'gurus' around here have been saying put trading 'psychology' last on the list.

In this different approach, would it now go first?

 

thx,

 

zdo

 

Have a great weekend all

[bootstrap 47]

i know that i am gonna get all kinds of hate mail, but don't confuse the method with the madness.

 

money management is not psychology. money management is risk management.

 

psychology is dealing with the fear and inability to follow the strategy that you determine to trade.

[jasont 10]

I am actually surprised this hasn't got more attention Chris. I actually have looked through the Money Management thread on this forum before and was surprised at the lack of threads (22 in total) in comparison to say the Technical Analysis threads which total 327.

 

Presuming the statistics of 95% of traders losing in this game over a longer term basis, I would say that according to this forum 95% of traders are working on the technical analysis more than the risk management. Something I have recently been guilty of myself.

 

What interests me the most, and something I have been relearning over the past few weeks is that if the answers are found in technical analysis rather than risk management, why wouldn't traders risk it all on each individual trade? I'm presuming most traders hear that you can't predict the market, yet from the looks of the amount of threads in regards to Technical Analysis in comparison to Risk Management would say that they don't believe it.

[greyowl 10]

Sorry -- double posted ...

Edited October 21, 2008 by greyowl
double posted

[greyowl 10]

Dear BootsTrap,

 

thanks for Your interesting articles...

 

May I get more and plain information on Your "different approach"

which sounds logical for my deep detecting mind -lol - ?!!

 

Please explain with patience, so we can understand

or send email or PM, if possible!

 

THANKS ALOT !:missy:

Rolf

[zdo 20]

i know that i am gonna get all kinds of hate mail, but don't confuse the method with the madness.

 

money management is not psychology. money management is risk management.

 

psychology is dealing with the fear and inability to follow the strategy that you determine to trade.

 

bootstrap,

 

Maybe my question wasn't clear. I wasn't confusing 'Psychology' with Money Management. Psychology is not on your list / sequences. The gurus have been saying ‘edge’ first / ‘fears’ last. My question was - if Psychology was on your new list, where would it go?

 

thx

 

zdo

[bootstrap 47]

in the frame of the question i would put it last. you can't build the discipline until you have an approach to the market to be fearful of.

 

but would you be as fearful if you built your strategy around risk management? what if you put as much thought into this piece as you do trying to find that set-up you are so desperately seeking?

 

if you start with risk management, would you just go with the standard:

 

" i am going to risk 2% of my account on any one trade. "

 

probably not, you might add some things like:

 

" i am going to adjust my position size throughout the trade based on the current risk level. "

 

" due to commissions, slippage, and spread resulting in a position starting out in the red, i am going to work these into my risk management. "

 

" to build my bankroll, i will use a scaled risk model based on my weekending balance. "

 

" i can only trade "X" and maintain my risk level."

 

if you spend quality time determining how you are going to protect and grow your capital (notice the order i put those two words in), why would you be fearful in trading the end result?

 

once you have your risk strategy down, move onto exits. what kind of exits support the risk being taken and still generate a profit?

 

you are now asking: "but how do i know where to put the exits, i do not know if i am long or short the market?" remember that you are in the development stage. so you are going to look at both. running a long and short trade at the same time.

 

"but i don't have an entry?" sure you do....its NOW. you are going to run this little madness test until you have 100 profitable long and 100 profitable shorts.

 

now design an entry that captures the profitable trades and limits the losers. you may have one entry for longs and another for shorts. or maybe not.

 

and finally the set-up. is there a common factor that is present in each of the profitable trades? what is it?

 

" but all this is making my head hurt! ".

 

yeah, but now you know how to build a strategy the right way. through every step you were thinking about risk. and that is what you shoudl be doing now.

 

set-up: find something that occurs regularly in the market. the set-up is nothing more than a set of conditions that are necessary to be in place. nothing more...

 

entry: entries should confirm the direction you are wanting to trade, and guarantee that you capture every price move it is designed for. nothing more, nothing less.

 

exits: how do i maximize my profit, and get out quick when i am wrong.

 

risk management: stretch the strategy to the limits imposed by your capital and risk profile.

 

good trading to you all....

[Trader Nick 10]

Great post... I just finished reading Tharp's money management and can see there was a lot of principles he discussed that I speed through..

[MetaDavid 10]

Hi, i'm new to the forum and to trading and i think this post was great, maybe with the correct risk-management the psychology part wont be so big.

 

Thanx for a nice post.

 

Regards

 

David

[MadMarketScientist 11]

MetaDavid

 

Welcome to the forums -- we hope you continue to read and participate in the forums -there's no better way to get the most out of it than participate at TL.

 

As for risk management here's my thoughts. In a former life in particular I did a ton of training and would always ask people what the biggest hurdles they are facing. Inevitably would get the usual answers - trade system, time it takes, complexity even a lot that would admit trade psychology but only about 15% would ever say risk management was their issue. However, when we dug deeper these very same people would have wiped out their accounts multiple times. And, when we looked at trades were trading position sizes that made no sense to their account sizes.

 

It's a far bigger issue and challenge than most admit - it's why though even too simplified, the 2% risk rule is a good starting point because most people never honor that - in particular in forex where I've seen the average risk per trade people take is 10% which is crazy. And wipe out city soon follows.

 

With reasonable risk management you'll buy yourself a lot more time to figure out all the other challenges in trading that usually lead to ruin -- I look at it like a video game - you get a lot more health points and stay alive - ideally long enough to figure it out.

 

 

MMS

 

 

Hi, i'm new to the forum and to trading and i think this post was great, maybe with the correct risk-management the psychology part wont be so big.

 

Thanx for a nice post.

 

Regards

 

David

[TheDude 10]

I think a lot of people confuse risk management and money management.

 

(For me: )

Money Management - how I look after and allocate my margin/money, where I keep it etc. e.g. my broker doesnt pay interest on balances, so I only keep enough in there to trade my maximum position.

 

Risk Management dictates (commonly) how much I'm willing to commit to a position and how, and stop management (I dont really like the idea of stops, but thats a different topic)

 

Given my money management, it would make no sense for me to risk only 2% (which is what everyone seems to do) of my account in my risk management plan. Generally, I will trade as large a position as I feel at ease with. Thats my risk management - if I feel uneasy, reduce size or get out!

[MadMarketScientist 11]

TheDude,

 

That's an interesting way to look at it and as I read what you described I can see what you mean. You make a good point and I agree it is important to look at both aspects - money and risk.

 

And, without a doubt ultimately it comes down to what you can personally handle psychologically. Everyone is different -- you don't want a trade to cause a heart attack or insanity - that's my filter!

 

MMS

[MetaDavid 10]

Hi again, No, one would probably like to keep the risk in a zone where mental breakdown is not imminent

 

So this is probably a question asked too many times, but is there any firmly set rules for risk-management from a position point of view that many beginners utilise?

 

Thanx

 

David

[MadMarketScientist 11]

MetaDavid-

 

There is likely no "right" answer for all cases.

 

However, I remain behind the general theory that no more than 1% - 5% of your capital should ever be at risk on a single trade. In fact, as your account grows you want to get that below 1%.

 

In addition, you need to be aware of correlation.

 

If you have one trade long on the EURUSD and another on the GBPUSD and risk 5% each there is plenty of correlation between the two - not 1 for 1 but it's highly correlated so you really are risking 10% -- probably not quite that much but close. So that plays in.

 

It would be like buying all internet stocks and risking 1% on each and feeling you have 1% risk when in fact due to correlation it might be much higher.

 

At any rate, from there what I would suggest is do simple calcs.

 

Starting account for example = $10,000

 

Risk 1% to 5% -- so that means $100 to $500 risk on a trade.

 

Let's say you decide it's 3% or $300 that is going to tell you what size you can trade based upon the full risk on the initial trade. Let's say you are trading Russell e-mini that means you can have a 3 point risk (or less) and be fine with a contract.

 

I honestly feel if you can keep it there or lower you'll buy yourself time.

 

My other recommendation is when you first start out, even if you can afford a larger position size based upon the calculation trade the absolute smallest position size you can because you're going to make plenty of mistakes. Better it's not with your capital.

 

Hope that helps.

 

MMS

[Kiwi 16]

Following up MMS's post.

 

Most beginners cheerfully risk 5% to 10%. And in doing so cause themselves extremes of psychological pain, because, as MMS said, you make mistakes.

 

This has the very bad effect of maximizing unplanned emotional learning. And building bad habits on top of mistakes.

 

So, most beginners should start by:

- initially risking zero (paper) to see if the system actually works in a walk forward test with no stress on the trader

- then risk the minimum amount possible (less than 1% and preferably under 0.5%) to put a little strain on the trader.

- then when its working ok gradually work their way up towards 1% or 2% risk per trade.

 

Going above 2% (a heuristic suited to systems with 50% win ratios, experienced disciplined traders, and few errors) requires 1. a history of your trades for analysis and 2. the ability to analyse then and work out your risk of ruined based on that series, and 3. the ability to translate that into some reasonable analysis of future risk.

[MetaDavid 10]

Thanx guys! I realise now that going small is the way to go.

 

MadMarketScientist-

 

I didn't even think about the correlation beetween the pairs from a risk-management point of view, thanks for pointing that out.

 

Regards

 

David