Risk Management

[CanOz]

Here's an example of some profit targets...

 

[howardbandy]

Greetings all --

I understand the use of exits rules implemented as trailing exits based on multiples of ATR. And on profit target exits and adjusting exits as the trade progresses. Systems benefit from having those exits.

But I recommend against putting position sizing calculations into the trading system -- that calculation cannot be done correctly from within the model. Rather, perform risk analysis and set position size as a separate process using a set of trades that represent whatever you feel is the best estimate of future performance of the system. Use recent real trades, paper trades, trades from whatever validation process was used during system development. Subjectively add whatever losing trades you feel are not already adequately represented. Keep this set of trades up-to-date with the addition of recent trades as they are completed. Then estimate the risk of drawdown and compute the maximum safe position size for the next trade that will keep the probability of having an account-destroying drawdown within your personal risk tolerance. Repeat before each new trade.

Below, I have pasted a posting I recently made to one of the other threads on ASF related to a discussion going on there about position sizing.

I will be giving two presentations at the ATAA Conference in Melbourne in May, 2014. The second presentation addresses this issue directly.
http://www.ataa.com.au/conference-overview.html
http://www.ataa.com.au/speakers-presentations.html

Best regards,
Howard

-------------------

I Strongly recommend keeping All position sizing Out of your trading system logic. The maximum safe position size depends on system health -- on the current degree of synchronization between the model (logic, rule, parameters) and the data. It depends on the distribution of recent trades -- most importantly the number and magnitude of losing trades.

This information cannot be adequately determined from within the trading system.

Including position sizing within the trading system will introduce an unfavorable bias that Always over-estimates profit and under-estimates risk.

Rather, use this procedure:
1. Use fixed size trades -- not even compounding -- for all development, including validation.
2. Create a set of trades that you feel are the "best estimate" of future performance. A good source for these is the set of out-of-sample trades from an uncontaminated walk forward run. Augment this set with whatever you subjectively feel is likely to occur in the future but is under-represented in that set.
3. Determine your personal "statement of risk tolerance." An example is:
I am trading a $100,000 account and looking forward two years. I want to hold the probability of a drawdown from maximum account equity, marked-to-market daily, of 20% or greater to 5% or less.
4. Use the Monte Carlo simulation techniques I describe in my Modeling book to estimate the risk of drawdown for the two year horizon using the best estimate set of trades.
5. Calibrate the initial value of the position size so that risk is within your personal risk tolerance. It will almost certainly be less than full fraction.
6. Rerun the Monte Carlo at that position size and analyze the distribution of profit. Decide whether the system is worth trading. Look beyond the mean -- perhaps at the 5th to 95th inter-percentile range -- to estimate the probable range of CAR given your level of risk.

If you do decide to trade the system, after every additional completed trade, add that trade to the best estimate set and rerun steps 4, 5, and 6 above. Adjust position size for the next trade accordingly.

When the system health begins to deteriorate, and it will, this technique will automatically reduce position size in advance of account-destroying drawdown. If the system fails completely, you will already know that the correct position size for a system that is broken is zero.

There is a flowchart and brief discussion in Chapter 2 of my "Mean Reversion" book. You can download that chapter for free:
http://www.meanreversiontradingsystems.com/book.html

There is a deeper discussion in my forthcoming book, "Quantitative Technical Analysis."
http://www.quantitativetechnicalanalysis.com/

Best regards,
Howard

 

[CanOz]

I just realized that the video I posted was from school of trade....please note that I only picked as an example of profit targets instead of trailing stops...

 

[Sellsword]

Hey all,

After some advice and tips on risk management.........

Hi Sam! Glad to see this topic posted, it's current for me as I've just started implementing risk management into my trading. I'm a pure TA trader.

What I do is measure the risk per TRADE. Some educators recommend tracking portfolio risk, you can do either or both IMO.

What I do;
1. Pick an entry point.
2. Pick the technical target, the exit. Measure the distance to the exit from your entry point. This is your reward.
3. Look at the bottom of the pattern.
4. Put a stop at the bottom or just below the bottom of the pattern. The distance between the entry and the stop is your risk.
5. If the ratio of Reward:Risk is 4:1 or greater, I enter the trade.

I know some people may disagree with this approach, but it's working for me successfully since I've started using the system.

Hope that helps.

 

[Boggo]

What I do;
1. Pick an entry point.
2. Pick the technical target, the exit. Measure the distance to the exit from your entry point. This is your reward.
3. Look at the bottom of the pattern.
4. Put a stop at the bottom or just below the bottom of the pattern. The distance between the entry and the stop is your risk.
5. If the ratio of Reward:Risk is 4:1 or greater, I enter the trade.

And its no more complicated than that.
In my case I will look at anything that is greater than 2:1 but on some testing I did years ago I remember finding 2.9:1 the be the ideal minimum R/R.
Item 4 above, I use ~$1000 as the risk amount, covers brokerage and a bit of slippage etc.

Follow on below from this previous example here
https://www.aussiestockforums.com/forums/showthread.php?t=28029&p=814098&viewfull=1#post814098

(Weekly chart - click to expand)