I'll do my best, but really this is a subject one could write a book about.the golden gun said:Jack, if you don't mind sharing, could you please detail how you control risk in your own trading, and at work(if it's different) ?
ICT has outlined a method of cutting risk after losing, that should allow you to hit a string of losses and not suffer crushing drawdowns. There is some little details to his method though, which I learned later on, and only by digging... such as he won't cut risk in half if the first loss isn't a "full loss". Have never gotten to see this risk-cutting in action though, but the logic behind it does seem sound.
so is that how you control your risk too? He makes it seem like every professional out there is doing this risk cutting thing, and I'm not so sure about that anymore.
To be up front: None of what I'm about to write is suggesting how ICT manages risk is incorrect. ICT's position sizing might still be best of his methods (and clearly it's the best for himself as a trader, trade psychology and money management wise, since that's how he, himself, approaches it.)
Money management, like other trading tools, varies in style depending on the strategy employed. The method ICT talks about (cutting risk on full loss,) is not one that I like myself. Yes, professionals tend to stop putting on enough size to blow one's brains when they think the system is out of favor with the market...but cutting things down after just one full bad trade is a bit too immediate/risk-adverse for my taste.
Generally speaking, I believe that you have to put some trust in your system (which is gained through proper experience and testing,) and thus a single loss could just be some noise and not a sign you need to scale back. A pattern of losses, or some adverse conditions such as the market itself changing thanks to economic forces outside of the setup's scope, may have me rethinking my size... but if a normal trade experiences an acceptable loss, I can't see myself scaling back.
(Plus, if you have properly backtested a trade setup--and by properly I mean correcting for confirmation bias and being as honest with yourself as possible about which trades you'd be taking part in--then you'll already have an idea about frequency of losses, average losing streak, maximal losing streak, etc.. etc.. so you should be able to find a comfortable size to trade based on this.)
So in order to be comfortable with a full loss, even multiple times in a row should it be a common outcome of a given setup, I risk a lot less per individual trade. I look to increase the frequency of the setups I take to compensate for this, and let the law of large numbers work itself out. (Don't get me wrong, there will be setups and conditions that make you push your risk tolerance on individual trades, but I'll get to that in a bit...)
I should point out that by 'increasing the setups I take', I don't just mean spreading out over other pairs, but instead I look to be adding different setups entirely to my "trader's toolbox" that relate little to each other. I mean, think about it, we have the London open, the NYC open, supply / demand, major levels, fundamental changes, news and event driven catalysts, price action, inter market correlations, etc.. etc... you could come up with many potential plays for different times of the day, during different market conditions. That's not an endorsement of any style I just mentioned, but I do hope that with ICT's 'teach a man to fish' approach that you guys have started to work on your own trading ideas outside of his work.
Ok, now here's the tricky part. I'd hate to sound tacky, cliche, or like an excerpt from Brian Tracy's self help material from the 90's, but return/risk wise I tend to observe the 80/20 rule. 80% of my time put into all these smaller trades probably only make up ~20% of my overall profit. However, they matter, a lot. They go to paying for the larger risks I take once I see a setup that's actually worth betting hard on...
I call this the "tricky part" because judging which setups are worth 'taking a shot on' can be hard for new traders.
In the past, I used to try to help new traders (at work, so equity based, not FX) by giving them a size limit while they are learning a new strategy, with an option to double this size limit should they feel the setup was perfect, or "worth it." I explain that if they end up taking 50+ trades in a day, there really should be just one or two "worth it" trades at most, since in the end, they are still violating their limit after all. I say "in the past" because in most cases, what ended up happening was the trader would take their first double sized position, lose, and all of a sudden every single trade there after that became "worth it" with double size. I used to think this was just a discipline problem, but in reality it's also an experience problem since they aren't very intimate with the strategy and simply don't have the experience to know when it was truly "worth it" in the first place (after all, there's more to a clean setup than how a few candle sticks line up on a chart.)
There's just something you get a feel for when you take the same kinda setup a few hundred times. You start to be able to tell when it's about to rip you a new hole even when it otherwise 'appears' to be a solid play.
Enter: The confidence level. I like to scale up and down dynamically based on how confident I am of a given setup. This confidence is set based on factors related to the setup itself and how it appears.
Often, I increase size by averaging 'up' (never down, as if I was so confident in a given setup, why would it be moving against me?) Or, I'll take the additional size right upfront should the strategy not be favorable for averaging up / pyramiding. This will cause my position size to vary greatly between setups.. on a day I'm not confident at all in a setup but feel like I need to be apart of it (see the above note on trusting your system,) I may only take my default (small) risk. On other days, when my confidence soars through the roof in a given setup because it's behaving exactly as I've seen it before with similar conditions in the market and I'm expecting a move much more favorable than I usually see, I may take up to 10x the risk (in the extreme cases.)
(Edit: To qualify the 10x remark. I might take a trade that's 10x my regular size maybe 1-2 times a month.. and I'm very happy to avoid doing so unless the setup was good enough to justify it. Typically, if my confidence gets high enough in a given setup, I might go 2-3x my size...)
The above would be the 20% part of the 80/20 rule, time wise, that makes up the majority of return. Though, I'll add that this is built upon leveraging existing gains, if I'm not already profitable in a given strategy, then how could I justify thinking I know when to up my risk? If the strategy works, getting net profitable on it overall shouldn't take long anyway... and if the strategy proves sour, then you're not gonna blow your brains out with a higher risk trade.
While it's good, hit it, milk it, but have a reason for why it was "worth it." The reason should NEVER be because you lost and need to make up for bad trades. And again, if you're not already net profitable (extra buffer) on the strategy, I'd shy away from getting 'cute' with position sizing.
I just wanted to reiterate the difference here between a n00b who doesn't know the strategy well enough and myself trading a strategy I've known for years. Trying to use discretion to scale up risk is going to end up in disaster if you do not possess a good command and intimate understanding of the strategy itself.