Risk 5% per trade and you have a 99% chance of 50% drawdown in next 5 years

Ok ok - it all depends on your win/lose ratio etc - but I thought I'd share a simple spreadsheet I created to check out any system you have going.

Put your figures in the green fields and it will show you how likely you are to suffer drawdowns over time.

I'm not a statistical genius and the spreadsheet only accounts for getting several losers in a row - not for a general decline in the account. So the percentages you see on the spreadsheet are the absolute minimum - the real chances are likely to be higher.

Even so they can be an eye opener. I've put in a pretty typical trading system, one that wins 35% of the time and winners are 2.5x bigger than losers, averaging 2 trades a day. Risking 5% of your account on each trade you are 99.6% likely to suffer a 50% drawdown within five years because of 14 losers in a row.

Have fun.

Also depends on how many trades you get per year.

If you make 500 trades per year they are going be 10 times more frequent (in time) than if you only make 50 trades per year.

Hello Hoggums,

Good work.

I dont think the "Probabilities of Losers in a row" colume is accurate if I'm reading it correctly , granted this bit is not the main focus of the spread sheet.

My thinking on probabilities of losers is something like this;

That table is per 50 trade period. Where my table is the probability that your next trade will be start of the losing streak

risking only 1% of my account....... I have a question.....

why are people risking 5% ?

Plug in 1% to that spreadsheet and open your eyes.

Captain Currency said:

Hello Hoggums,

Good work.

I dont think the "Probabilities of Losers in a row" colume is accurate if I'm reading it correctly , granted this bit is not the main focus of the spread sheet.

My thinking on probabilities of losers is something like this;

Click to expand...

That's quite a comforting chart in a perverse kind of way.

*JDR* said:

risking only 1% of my account....... I have a question.....

why are people risking 5% ?

Plug in 1% to that spreadsheet and open your eyes.

Click to expand...

exactly...
I put my numbers in an got 0.0% probability !

nice spreadsheet really, maybe simple, but expresses the risks involved...

leonarda said:

exactly...
I put my numbers in an got 0.0% probability !

nice spreadsheet really, maybe simple, but expresses the risks involved...

Click to expand...

I was worried I was the only one.

I'm afraid to say but if you have to risk 5% of your account to make money or trade for a living ........your account is not big enough.

If your aim is to trade full time (and lets face it you are here so that is likely)

Grow your account slowly......... you will learn more and be a better trader when you do finally have a big enough account to take the plunge.

1% risk here. No need to bet the farm.... Even if I only get 60% returns a year, I will be millionaire in a few years, so i'm not that worried lol

10k in 10 years at 60% turns out to be 1.1 M I have all the time in the world.

Of course that is if you don't use trading as income. I don't, I let it compound over and over and swing trade so i can do that while working my job

*JDR* said:

risking only 1% of my account....... I have a question.....

why are people risking 5% ?

Plug in 1% to that spreadsheet and open your eyes.

Click to expand...

If you were 100% certain of a trade going your way it would be completely logical to risk 100% of your account. How much you risk should depend on the likelihood of the trade being a winner, and your judgement of the likely returns from the trade. Or in other words, your risk needs to be tailored to the individual trade, not some generic number like 1% that is plucked out of thin air and bandied around forums like it's the holy grail of risk management.

virtuos0 said:

If you were 100% certain of a trade going your way it would be completely logical to risk 100% of your account. How much you risk should depend on the likelihood of the trade being a winner, and your judgement of the likely returns from the trade. Or in other words, your risk needs to be tailored to the individual trade, not some generic number like 1% that is plucked out of thin air and bandied around forums like it's the holy grail of risk management.

Click to expand...

while i do agree that there may be some room to adjust the amount you risk per trade, given some trade set-ups will carry a higher probability of success, i think if your first goal is capital protection, and then growing equity over the long term, i think this adjustment should only be around the edges of some predetermined parameter (ie 1%)...generally speaking, i think sticking close to some predetermined rules on risk per trade IS the holy grail of risk management!

virtuos0 said:

If you were 100% certain of a trade going your way it would be completely logical to risk 100% of your account. How much you risk should depend on the likelihood of the trade being a winner, and your judgement of the likely returns from the trade. Or in other words, your risk needs to be tailored to the individual trade, not some generic number like 1% that is plucked out of thin air and bandied around forums like it's the holy grail of risk management.

Click to expand...

Sorry.

I most definitely do NOT agree.

The 1% is important to me.

It is the amount I am comfortable losing on every trade.
It is the amount that helps me not care about a trade anymore that has been executed.
It is the amount that I know that after 10 losses in a row I'll still be comfortable and in the game and not start doubting myself..... even at 20 losses in a row - still pretty comfortable. (though thankfully this has never happened yet)

What do you have in your plan?

"I'll risk whatever I feel like if I think the trade is certain"

Let me tell you. No trade is certain.

So you put your whole account into the trade and it goes against you..... it drops 5%.... but your certain right? this is a sure winner..... so you don't get out..... it drops 10%..... trigger now? or are we still certain?..... it drops 20%...... now what?


What you are talking about is another part of risk management. And that has to do with volatility and size.

A very basic example.

A have a very volatile trade. My rules tell me how much I am comfortable losing on each trade (1%). So this and the volatility helps determine my size.

If I have to have a stop 10% off my open to give the trade a chance to develop and not get hit by noise then I reduce my size. On the other side of this is those that are not volatile. I can comfortabley increase my size and set my stop tighter.

But the amount you are comfortable losing each trade is important.

I think Virtuoso's point is that risk mgmt doesn't have to be as formulaic as is generally peddled.

Each to their own and the amount of risk per trade they decide to take. After all, each person know's their own system better than anybody else.

What do you have in your plan?

"I'll risk whatever I feel like if I think the trade is certain"

Let me tell you. No trade is certain.

Click to expand...

..and here is where we run up against the same old thing on these forums. If you feel this way about your risk management then you aren't trading, you're guessing. Or gambling if you want to call it that.

The only logical way to look at risk is not by considering "what am I willing to risk" in a generic sense, it's about appraising the probability of the trade being a winner, and then acting accordingly.

To take some examples from the real trading world (away from the bizarre parallel universe of retail trading) take Soro's infamous short sterling trade. His CIO Stan Druckenmiller wanted to risk a small amount on the trade, but Soros saw that rising interest rates to try and control and appreciate sterling, were unsustainable, and that only way the pound could go was down. So acting on this insight and his experience he told Stan to massively increase the leverage in the trade, and the rest is history.

Another example is the current Galleon affair. They were (ALLEGEDLY) paying prime brokerages for 'market colour' or in other words orderflow information, not to mention information directly from corporations. Due to this market information Galleon were confident in increasing their risk, and hence their Alpha was pretty much the most consistent in the industry.

Therefore in the first example risk was judged based on knowledge, experience and insight, and in the second example risk was judged based on superior information. If Soros and Galleon were just 'guessing' (as the retail trader likes to) then they would be utterly stupid to run the risks they did.

You're making the assumption now that retail trading is value-informed and from what I can see (including myself btw) it isn't. Therefore the only edge retail has is in a mathematical and execution sense and is based upon the probabiity of a trade going right under only those conditions. Therefore risk per trade has to be static because you're trading under a static method. The only edge retail has is by using some sense of fundamental and price action to produce improved calls on market direction for what essentially is speculative short term trading opportunities rather than longer term, value informed trading.

virtuos0 said:

If you were 100% certain of a trade going your way it would be completely logical to risk 100% of your account. How much you risk should depend on the likelihood of the trade being a winner, and your judgement of the likely returns from the trade. Or in other words, your risk needs to be tailored to the individual trade, not some generic number like 1% that is plucked out of thin air and bandied around forums like it's the holy grail of risk management.

Click to expand...

Absolutely. Sometimes there are occasions when piling in in the biggest size possible is what you should do. This is usually because of some news.

virtuos0 said:

..and here is where we run up against the same old thing on these forums. If you feel this way about your risk management then you aren't trading, you're guessing. Or gambling if you want to call it that. **snip**

Click to expand...

Never said you were gambling.

But by risking more per trade it takes less losses to wipe out your account.

Do you really think you can ever have a trade that is a 100% certain winner?

I approach every trade as though it is the next loser. Yes that means also that my return will be limited. But if I am right I'll also carry on without another thought.


You use two succcessful trades as examples.

What about all those we hear about that were unsuccessful. I'm sure they felt 100% sure also.

http://en.wikipedia.org/wiki/List_of_trading_losses

Nothing is 100% sure. Soros trade wasn't either. It paid off for him. But I am sure he knew enough to know that it wasn't a 100% winner.

*JDR* said:

Do you really think you can ever have a trade that is a 100% certain winner?

Click to expand...

On news, yes

robster970 said:

You're making the assumption now that retail trading is value-informed and from what I can see (including myself btw) it isn't. Therefore the only edge retail has is in a mathematical and execution sense and is based upon the probabiity of a trade going right under only those conditions. Therefore risk per trade has to be static because you're trading under a static method. The only edge retail has is by using some sense of fundamental and price action to produce improved calls on market direction for what essentially is speculative short term trading opportunities rather than longer term, value informed trading.

Click to expand...

Rob,

I'm not making any assumption about method, I'm simply saying that your risk should be based on the probability of the trade being a winner and how profitable that trade is likely to be. That doesn't require any information about method in order to be universally true.

If a retailer is trading/gambling under the conditions you describe, then their risk per trade should of course be absolutely tiny, and possibly static. In fact, realistically, your risk per trade should be 0% because you shouldn't be trading at all.

What I am arguing against is *JDR*'s very narrow and incorrect view of risk management which is based on a limited understanding of what trading is.

arabianights said:

On news, yes

Click to expand...

If that were the case.....

who is taking the other side?

No one would take the other side so there would not be a trade.

It is a 100% certain loss for them.