This is a discussion on my journal within the Trading Journals forums, part of the Reception category; ...
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|Dec 6, 2009, 2:58am||#1130|
Joined Mar 2003
How greed affects your risk/reward aiming
I have run out of things to complain about. I've said enough about my dad and my colleagues. I would do myself and everyone a favor if I stopped wasting time writing and saying the same things over and over again. Maybe I am ready for a change. For a change in habits. At least that.
What I've always wanted is a more radical change: to quit my job. Every morning I sit at my desk and whisper "quanto manca?". How long more? How much more time? How much more of this? I know that's the major source of my frustration. But that's exactly what's kept it from happening: wanting it too much. Aside from my gambling that's what hurt my trading: a desire to make money quickly so to quit my job as soon as possible. I caused the opposite to happen because the quicker I wanted to make it, the quicker I lost it.
That strong drive to make money blinded me into making improbable trades. The more I wanted to quit my job the more I was neglecting the unprofitability of my choices. By the way, I was just googling "blinded into making" to see if I could use that expression, and I found this other trader who describes the same concept here: "Well, on hindsight, the read on the second trade was full of wishful thinking.... After a successful trade, the euphoria and greed blinded me into making a trade that was not supported by any evidence".
That's why they're all talking about discipline - and since everyone is talking about it, as usual I assumed it was bull****. Yet discipline is what I need, to prevent myself from letting my desire to quit my job blind me so much that I'll make unprofitable choices. If trading were like the lottery, and I all I needed was to win once, then I could try all improbable trades I want. But since I need thousands of trades before I can quit my job, choosing improbable trades will not work.
It's like when you're playing a video game and you're wasting ammunitions - you aren't even trying to aim. Or when you're playing risk and you keep on rolling the dice until you're down to one army even though you know the odds are against you. If I don't want to call it "discipline", because that's what everyone calls it, then let's say that I better calm down, because the more I rush to conquer the world, the faster I will be wiped out from the map. This is all about being a sniper and aiming and not about shooting away and firing at will. As far as my discretionary trading, every bullet costs me 250 dollars, and so, with 5000 of capital left, since margin is 2500 dollars, I have ten more bullets to go. Each time I hit the target, I gain one bullet. Each time I miss, I lose one bullet.
Last edited by travis; Dec 6, 2009 at 12:37pm.
|Dec 6, 2009, 6:55am||#1131|
Joined Mar 2009
Re: my journal
travis ur right man,about leaving this job and free,i have the same feeling,u ahve this longing to be away from all this boring and stressful stuff and be away on some sunny beach and enjoying nature but what can one do.time is not with us.one is constraint somehow in so many chains.even one wants it u cant break it.but on the other hand think of it this way what is the purpose of it all,suppose one has all the freedom and u can do whatever u feel like then the problem arises, how one going to structure his/her time.u can't be doing this boring stuff called trading,meditation,enjoying nature all ur life.some how life get u and forced u to in this world of comparision,life and death,day and night,black and white,light and darkness...and so on.there is no way one can comes out of it and be urself.there is too much noise in this world.but again probably one need it so that one can keep sane oneself...hmmm
|Dec 6, 2009, 12:57pm||#1132|
Joined Mar 2003
Re: my journal
Hmmm... ok, so we need to keep the bad, as a term of comparison, to appreciate what's good. Yes, it makes sense. But then we could take it further and say that instead of eating a cake, we could starve ourselves to death, and just eat a piece of bread, and it would taste better than that cake. Or we could deprive ourselves of things, in order to enjoy our regular life. I don't know. Yes, we could. It doesn't feel natural at all though. What feels natural is to get better and better and more and more. If I could do what you're talking about then I could stop trading, because my job gives me enough to live, and if I am unhappy I can always resort to starving myself to death, in order to appreciate bread and water again. And if I am unhappy with my job, I could go work in a coal mine for one day, or similar. Yeah, I guess I could manipulate myself to be happy in any situation. But I would be manipulating myself... it reminds me of that movie, Matrix.
|Dec 6, 2009, 5:58pm||#1133|
Joined Mar 2003
Mentally preparing for tomorrow...
Preparing for tomorrow, renewing my promises and resolves, here's the plan I will have to follow from now on:
1) Automated: safe money management parameters, and no interfering with anything.
2) Discretionary: just one daily trade allowed, and it has to follow all rules in system.
If I'll follow such rules, realistically, I hope to make about 1000 per week: 500 from discretionary and 500 from automated. It's going to take me one month to get back to 10k. Then, with 10k, following the same rules (but doubling the contracts on discretionary, and with more automated systems trading), I should be able to increase my capital by 2000 per week. And so on. Basically, instead of aiming at 100% per week, I am aiming at 100% per month, and this way, like the sniper I should be, I won't waste my ammunitions: one shot per day. Realistically, I am planning to make 100% a month. Same old dream/plan.
If it doesn't happen, I'll come here to report it, as usual. If it happens, once I'll get to 20k, I might stop posting because it means I have finally learned to be profitable, and it's useless to show off.
I must be like a sniper...
Last edited by travis; Dec 6, 2009 at 6:41pm.
|Dec 6, 2009, 8:12pm||#1134|
Joined Mar 2003
Continuing the trader/sniper analogy...
Continuing the trader/sniper analogy. My gun is my bracket order. We could say that part of my gun - my "sight" - are also the moving averages and the pivots I use. So I have this "+/- 20 ticks bracket order rifle", and I shouldn't be changing it, because it'll take me a while to get used to it and because, whether good or bad, with practice I can learn to hit targets with it. But each time I'll miss, I'll incur a cost of 250 dollars per bullet. Each time I'll miss the future direction of price, the market will wound me by destroying 250/5000=5% of my account.
When I wasn't using a stoploss, I was engaging in a duel/showdown with the market, where I either won or I was killed and my capital wiped out. But when I won, I would only take 250 dollars out of the market, and therefore I'd have to fight more duels, each time risking my life. That's why I ended up dying 30 times, regardless of how good I was at shooting.
So risk/reward could be compared to how much you'll be hurt if you miss vs how much you'll hurt your opponent if you hit. But alone it doesn't mean much: you need to know how good you are at aiming. So it's risk/reward plus percentage of wins. Yeah, because if you have a bracket order of -1 and +10, your risk is -1 and your reward is +10, which is awesome, but if you end up losing 9 times out of 10, with commissions, it's still not convenient. So this relentless talking about risk/reward is actually crap, isn't it.
Last edited by travis; Dec 6, 2009 at 8:20pm.
|Dec 6, 2009, 11:39pm||#1135|
Joined Apr 2008
Re: Continuing the trader/sniper analogy...
To reiterate/explain: It's meaningless to talk about risk:reward ratio in isolation. It can only be meaningful if you also always combine it with the win:loss ratio expected for that risk:reward ratio (and vice-versa), because only if you have both values, can calculate your APPT which stands for "Average Profitability Per Trade" (also known as "Expectancy" as used and described by Van K. Tharp in his book.)
It is obvious that unless you are on average net profitable your account balance will decline over time (even if you have the occassional upswings). We're talking averages here. And that if you *are* on average net profitable, your account balance will increase over time (even if you have occassional drawdowns which are not too severe to overcome).
The formula is (hopefully simple!):
APPT = (Average Winning trades % x Average Win size) - (Average Losing trades % x Average Loss size)
For example, let's say that on average you profit on 2 out of 10 trades (so you lose on 8). This means you have a 20% (0.2) win rate and a 80% (0.8) loss rate. This means your win:loss rate is 1:4. Let's also say that on average, you win $1200 when you win and you lose $300 when you lose. This means your reward:risk rate = 1200:300 = 4:1. You might think that with such a high reward:risk rate you should be profitable. However let's see what the sum says:
APPT = (0.2 x $1200) – (0.8 x $300)
= 240 - 240
= $0 on average
So you're only net break even, on average! Despite having a 4:1 reward:risk ratio! So, looking at reward:risk without taking into account win:loss ratio/probability is... meaningless!
Let's now say you you profit on 8 out of 10 trades on average ( so you lose on only 2 out of ten.) This means you win on 80% of your trades (0.8) and lose on 20% of your trades (0.2) and your win:loss ratio is 80:20 = 8:2 = 4:1, which one might think is obviously quite high and on the face of it very good. One might think that you have to make money with such a good win:loss rate. (Such a high rate plays into our "wanting to be right bias" of course...)
Suppose further your average win size is $200 while your average loss size is $1000. This means your reward:risk ratio is $200:$1000 so is 1:5. Here some alarm bells should be ringing as that's a very low reward:risk ratio, but the jury's out until the sum is done. The APPT then is:
APPT = (0.8 x $200) – (0.2 x $1000)
= 160 - 200
= -$40 on average
So despite the very good win:loss rate (4:1 or 80% of trades won) you will still be a net loser with a system that trades like this.
But notice, if you can reduce your average loss size to say $500, the sum becomes:
APPT = (0.8 x $200) – (0.2 x $500)
= 160 - 100
= $60 on average per trade
Which is net profitable, despite the fact that the reward:risk ratio is still relatively low at $200:$500 = 2:5 = 1:2.5 = 0.4:1. Which again shows that reward:risk is meaningless without win:loss.
Let's finally do an example where your win:loss rate is 1:2. This means 1/3 of trades are won and 2/3 of trades are lost. Suppose further your average win size is $1500 and your average loss is $500, which makes your reward:risk ratio 1500:500 = 3:1. Then the sum becomes
APPT = (0.333 * $1500) - (0.666 * $500)
= $500 - $333.33
= $166.67 on average
So a system with a relatively modest win:loss rate which only wins on 1/3 of trades, but has a decent reward:risk ratio of 3:1 is net profitable to the tune of $166.67 per trade. As an aside, I'll finally just observe that the net profitability (per trade) of the system is roughly one tenth of the average win size of your winning trades. It would be wildly unrealistic to estimate where you'll be profit wise based on the average size of your winning trades ($1500) and instead should use the more modest net average profitability size which in this example is $166.67. Just something to think about.
What all this hopefully illustrates is that reward:risk and win:loss are equally important when evaluating your trading system's quality. It is meaningless to look at only reward:risk (assuming win:loss will be ok by magic) or only win:loss (assuming reward:risk will ok by magic).
I'll finally emphasise that what further complicates matters is that these 2 measures/variables are in fact interrelated, and not independent variables in a trading system. It's like a complicated machine with 2 dials on, one for win:loss rate, and one for reward:risk rate. One might think you can modify your system to try and improve one of them without affecting the other, but in practice it usually doesn't work like this. Typically you'll find that when you start adjusting your system to increase the win:loss rate (for example), you'll find it in turn affects the reward:risk rate negatively and vice-versa. So the challenge in good trading system development is to tune/design/tweak your system so it's net profitable overall, e.g. get to a point where the 2 variables namely win:loss and reward:risk ratio's gives you a net profitable system, despite these 2 variables being semi-dependent. (As an aside, this is why I enquired in a previous post whether you've calculated the expectancy of your systems.)
For reference, I looked at this page while constructing this post.
Apologies if you already know all this. Good luck for your trading week.
At the risk of stating what might be obvious, what I've not said anything about is how to calculate the APPT for your trading systems. Well you need to basically calculate the following values:
1.) Average Winning trades %
2.) Average Losing trades %
3.) Average Win size
4.) Average Loss size
So for 1.) pull all your trades, count the number of winning trades, and work out the % they make up of the total. For 2.) The difference between that and 100% is obviously the % losing trades (but obviously you can just count the number of losing trades again if you like, and work out the % they make of the total.)
Next for 3.) sum up all the winning trade values only and calculate the average value of them all. Next for 4.) similarly sum up the average losing trades and calculate the average. Finally substitute the found values into the formula as was done above.
As an aside, you may also want to look at the maximum lost trade size, since if this is very much bigger than the average loss size then the resultant APPT/expectancy value may in fact be a bit optimistic in practice. (Van K. Tharp actually uses, if I remember correctly, the maximum loss size for no.4, rather than the average loss size, since that is obviously more conservative as it's "worse case" (and has the effect of forcing one to be strict about stop losses...) But don't quote me on that -- I'll have to go look that up sometime and get back to you to be sure I'm not misquoting/representing him.
Anyway, I hope that's helpful, if not then just ignore it!
"Most people don't lose because of what the market does but because of how they respond to the markets ... and how they handle losing trades." - From a review of "What I learned losing a Million Dollars" by Jim Paul and Brendan Moynihan.
Last edited by wprins; Dec 7, 2009 at 1:19am. Reason: Added some bits.
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|Dec 7, 2009, 12:09am||#1136|
Joined Mar 2003
Re: my journal
Just a quick reply, and later I'll read your formulas in detail (it'll take me a while). Thanks for taking the time to clarify, with formulas and examples, what I was stating: that talking about risk/reward (by itself) is crap. Saying "always know your risk/reward" is like saying "always know that 1 = 2", because you're omitting "+ 1".
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