Risk

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garyfritz

Re: Risk

Post by garyfritz »

The math does not agree, Khalid, unless you are risking too much.

According to well-understood position sizing formulae and simulations, increasing risk (position size) increases profit AND drawdown, up to a point. Beyond that critical point drawdowns continue to increase but profits decrease. I can show you a simple trading/betting simulation to demonstrate this, if you'd like.

The million-dollar question is "where is that critical point?" Unless you analyze your system's history, you don't know. There are various ways to find that critical point; Kelly criterion and Optimal f are two examples.

And you want to know where that critical point is, because you should stay far FAR away from it. At that critical risk level, you will experience brain-melting drawdowns, in the ballpark of 90-95%. You should risk much less than the critical level, so your drawdowns stay in a range commensurate with your risk tolerance. If you analyze your trades so you know where the critical point is, you can select a risk level that is a known fraction of that critical risk level. That gives you a good idea of what level of drawdown to expect.

If you don't do the analysis, you have no idea where the critical point is -- you are wandering around near a cliff, with a blindfold on. Most traders don't do the analysis. Given that lack of knowledge, you have to pick a risk level that you hope won't ruin you. Risking 1% is the standard rule-of-thumb level. There is nothing magic about 1%, but for most worthwhile systems, it is a very conservative level and it should be safe. For many systems you will likely accept much lower returns than you might have chosen if you understood your system's risk parameters. That (and never knowing if you're near the edge of the cliff) is the price you pay for not understanding your system's behavior.

Rather than trading blind and guessing a one-size-fits-all risk level, I prefer to analyze and understand the risk parameters for the particular system I'm trading. That lets me select a risk level that provides a high level of return but with well-understood risk of drawdown.
garyfritz

Re: Risk

Post by garyfritz »

Um. OK, but I'm not quite sure what my misguided assumptions were. You stated profits are "more often" inversely proportional to risk. I said that's true only if you're risking far too much, and talked a bit about what "too much" means. That all seems very relevant to your point. Did I misunderstand you?

I'll look forward to your response!
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Gamma_gallus
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Re: Risk

Post by Gamma_gallus »

Thanks Khalid for grouping all those quotes, very nice job !
Money management ones are essential to survive in this world.
coleen
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Joined: Thu Feb 14, 2013 11:54 am

Re: Risk

Post by coleen »

Yes, I agree thanks for information.
shayanjameel08
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Joined: Sat Oct 19, 2013 10:30 am

Re: Risk

Post by shayanjameel08 »

One form of risk management is controlling your losses. Know when to cut your losses on a trade. You can use a hard stop or a mental stop. A hard stop is when you set your stop loss at a certain level as you initiate your trade. A mental stop is when you set a limit to how much pressure or drawdown you will take for the trade. Figuring out where to set your stop loss is a science all to itself, but the main thing is, it has to be in a way that reasonably limits your risk on a trade and makes good sense to you. Once your stop loss is set in your head, or on your trading platform, stick with it. It is easy to fall into the trap of moving your stop loss farther and farther out. If you do this, you are not cutting your losses effectively and it will ruin you in the end.
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