Trades "worth" the extra risk.


jack

Administrator
Staff member
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.
I'll do my best, but really this is a subject one could write a book about. :p

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.
 

the golden gun

RINSE & REPEAT
Is this pretty much the general consensus of the traders you know and work with?

Also, when you say 2-3 or even 10x your "normal" risk.... what is the normal risk value? I'm assuming it is smaller if 10R is something you can stomach (even once or twice a month).

Interesting perspective though... I'm just questioning the whole process. There's a fine line between discovering your own comfort level and flat out trying to re-invent the wheel. I'd rather just trust the risk strategy and focus on entries and tight stops.
 

jack

Administrator
Staff member
the golden gun said:
Is this pretty much the general consensus of the traders you know and work with?

Also, when you say 2-3 or even 10x your "normal" risk.... what is the normal risk value? I'm assuming it is smaller if 10R is something you can stomach (even once or twice a month).

Interesting perspective though... I'm just questioning the whole process. There's a fine line between discovering your own comfort level and flat out trying to re-invent the wheel. I'd rather just trust the risk strategy and focus on entries and tight stops.
General consensus? It's my take on the subject (since you ask how I control risk,) but with variations I'm in the same ballpark as a few other respectable traders I know though work and such (..at least of the ones I look up to.)

10x my normal risk would usually mean if the trade doesn't work out I'm probably going to be well over my risk limit and locked out for the remainder of the day (we impose max risk limits at work.) So yeah, it would have to be one hell of an opportunity for me to justify that outcome. Ideally, I'd want to give myself plenty of room to work with (daily limit wise) so if I take a hit or two I can keep on trading and likely recover by day's end (or at least be open and able to take another opportunity should it arise.)

My normal risk is usually 1/10th to 1/7th of my daily max loss. It's also good to note that just because I've structured my trade to be a given fraction of my daily limit, I will get out for less if I have reason to close it out early.

Again, this is me speaking about my take on it.. it's what I've found works best for me. There are other methods that are just as valid which also work.
 

sqa

Village Scribe
ICT teaches his system for two reasons:

1) Learned from experience, and
2) Retail traders need a "net" to stay in the game.

Now, after actually working it out for myself, it gets a lot more complex (deal with "What's my max risk exposure with X number of trades on?" for a minute, to see where it goes), but it's a good system.

There's also the other issue: ICT is a US-Based trader. That means he (and myself) are stuck with FIFO rules and 50:1 max leverage. That's actually a lot harder to blow up an account on than others with a lot more leverage. It works out to roughly 7% on 30 pips is the maximum you can put on. Since a lot of ICT's followers aren't US-based, they have a much bigger gun to blow their account up with.

At the same time, the question for Jack is this: A "good" day is what % of your Maximum Equity? One thing about Prop Shops is the trader has access to a lot more Money than retail traders. So Jack is said about 1/7th or 1/10th risk exposure, so the "good" return is likely not a huge % on the much larger pool of money. I'd be surprised if 2% return on a day isn't a really, really good day. That's the differential playing field.
 

the golden gun

RINSE & REPEAT
Jack said:
General consensus? It's my take on the subject (since you ask how I control risk,) but with variations I'm in the same ballpark as a few other respectable traders I know though work and such (..at least of the ones I look up to.)

10x my normal risk would usually mean if the trade doesn't work out I'm probably going to be well over my risk limit and locked out for the remainder of the day (we impose max risk limits at work.) So yeah, it would have to be one hell of an opportunity for me to justify that outcome. Ideally, I'd want to give myself plenty of room to work with (daily limit wise) so if I take a hit or two I can keep on trading and likely recover by day's end (or at least be open and able to take another opportunity should it arise.)

My normal risk is usually 1/10th to 1/7th of my daily max loss. It's also good to note that just because I've structured my trade to be a given fraction of my daily limit, I will get out for less if I have reason to close it out early.

Again, this is me speaking about my take on it.. it's what I've found works best for me. There are other methods that are just as valid which also work.
thank-you for sharing your insights.

well I guess something comparable for me would be to say my max. loss for a day is 3% and then be risking 0.3% normally, and maybe 0.6-1.0% on good trades, and up to 3% on the truly exceptional trades.

the problem I find with "discretionary" risk control measures is the trades I think are the best, are more often than not just the really sneaky traps set by the market makers. but that's my own shortcoming, even ICT states he uses discretion with deciding risk, risking his most on trend trades, and holding back when he thinks the trend might be out of steam, or is trading against the grain.
 

jack

Administrator
Staff member
sqa said:
ICT teaches his system for two reasons:

1) Learned from experience, and
2) Retail traders need a "net" to stay in the game.

Now, after actually working it out for myself, it gets a lot more complex (deal with "What's my max risk exposure with X number of trades on?" for a minute, to see where it goes), but it's a good system.

There's also the other issue: ICT is a US-Based trader. That means he (and myself) are stuck with FIFO rules and 50:1 max leverage. That's actually a lot harder to blow up an account on than others with a lot more leverage. It works out to roughly 7% on 30 pips is the maximum you can put on. Since a lot of ICT's followers aren't US-based, they have a much bigger gun to blow their account up with.

At the same time, the question for Jack is this: A "good" day is what % of your Maximum Equity? One thing about Prop Shops is the trader has access to a lot more Money than retail traders. So Jack is said about 1/7th or 1/10th risk exposure, so the "good" return is likely not a huge % on the much larger pool of money. I'd be surprised if 2% return on a day isn't a really, really good day. That's the differential playing field.
Right, regarding what ICT teaches for money management, that's why I made sure to state this:

Jack said:
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.)
But about leverage: 50 multiples of your deposit is still enough rope to hang yourself. People who complain about 50:1 limits in the USA confuse me, as 50:1 is quite risky in itself. To expand on the numbers you gave:

USD$1,000 account on 50:1 risk == USD$50,000. Say we want to max out a EUR/USD trade, thus we need to buy EUR @ ~1.12 (wow, that number sure has gone down,) and we get ~44,000 Euros worth of exposure. Such a trade would have a pip value of USD$4.4, or $132 in a 30 pip stop out. ....That's 13% of one's account within a single trade, or in my language: Inappropriate risk.

For some reason there's a bunch of people who don't like the reasoning above. They either consider just a hundred bucks or so not a big deal (regardless of the account size) or they think they can apply more risk all the time and just win enough to have a positive equity curve. Often I'll ask: If you had a $1 million dollar account, would losing $130,000 in a single trade seem acceptable to you? And their answer is always "fuck no, I'd never risk that much." Yet, the %'s are the same, and if you're not going to treat money management properly when your account is small, you simply aren't likely to properly grow your account to a large one anyway (it will find ways of remaining small, either blown out and reloaded by yourself over and over, or just having a losing streak or two that decimates it back to a smaller balance.)

I think I've heard ICT reflect this next sentiment before, but I could be wrong as I might be thinking of Rob Booker... my advice here is to treat risk correctly and if you're finding the level of consistency needed to depend on returns, add to the account slowly to help it grow. Don't try to force a small account to produce huge returns. Let it compound and let the numbers do the work once it's gotten larger.

Psychologically speaking, it's also a hell of a lot harder to deal with +/- 40% swings in equity than it is +/- 4%.

Lastly, as for your question to me about % returns at a prop shop.. We simply don't go by % on equity returns. It's not a realistic way of measuring things for us. I've been asked about this by people who want to size me up against their personal returns and often they just get frustrated when I can't answer what % returns I do. (Not to mention I think that comparing % returns is silly, since that's just a function of risk applied..)

I read a great book recently which has a segment on this prop vs retail and % returns subject called One Good Trade by Mike Bellafiore. Google books happens to capture the part in their book preview:

Google Books preview.

Put another way, comparing my $ returns against how much buying power I have would be like comparing your $ returns against the max notional trade value your account can afford to margin, not the account value itself.

I basically only care about two things: My risk limits within a day's time, and what my numbers are for the month. I then solve for fitting my strategies within my risk limits to keep myself alive throughout the day and open to taking on good setups as they appear.
 

jack

Administrator
Staff member
the golden gun said:
the problem I find with "discretionary" risk control measures is the trades I think are the best, are more often than not just the really sneaky traps set by the market makers. but that's my own shortcoming, even ICT states he uses discretion with deciding risk, risking his most on trend trades, and holding back when he thinks the trend might be out of steam, or is trading against the grain.
And that's why I pointed out how I stopped giving discretion in size as an exercise to new traders. The experience is just not there.

I'm not saying you're inexperienced in general though.. it's just a matter of getting to know the strategy better. I did mention there's more to a good setup than how candlesticks line up.

Put another way: Traders learn to focus on risk as they start taking trading more seriously, then learn to hate risk (not to hate losing, but simply dislike taking on more risk than what's required for a given opportunity.) And with that in mind, they'll eventually get so comfortable and so confident in a specific trade/strategy that they'll feel silly for not taking more risk when all the stars are aligned and their anticipation of a given move is at its most heightened state. This feeling is very distinct for me (and I assume others.)

Again though, new traders really struggle here, since the noise of it all and inexperience trading the same setups in different market conditions can trick them into size they shouldn't be taking. I've gotten the impression that a new trader needs to take a given setup hundreds of times, over many different types of market conditions, before becoming able to add their own discretion to the setup in a way that yields a net positive impact on results. To be clear, I'm talking about a new trader in general, more experienced traders who've already obtained this level with other strategies might take less since a lot of market experience overlaps.
 

jack

Administrator
Staff member
Jack said:
This feeling is very distinct for me (and I assume others.)
I should add that the mental state is different for sized up trades from a new trader to a professional. A new trader might be devastated should they take a loss on a trade they had the most confidence in, and having extra size on said trade might even make it harder to realize that loss... but I find whenever I go 'full nut' on a trade I feel is "worth" it, and lose, I'm very much so level about the experience. Sure, losing money sucks, but when I've sized up right given the setup, I tend to feel pretty ok with the outcome even if it's negative (after all, I accepted the risk going in and felt I would gladly 'pay' that risk to be apart of the trade.)

If a loss on your size is emotionally devastating you, or bothering you enough to turn you to some vice to get over it, I'd say there's something wrong that needs to be corrected first and you should be sizing down across the board.
 

$erenityNow

Active Member
Good stuff, thanks for sharing. I am of the opinion that I must be as dynamic as the market conditions. I assume different risk levels once daily/weekly/monthly profit targets have been met. If i'm at my targets or negative for the time period, then risk remains constant until it falls outside my assumed standard deviation for risk. At that point, I have to assume a core systemic flaw in my strategy given the existing conditions. More often than not, I exit the market until that particular strategy is valid again rather than reducing risk. I reason that if my strategy can't hold water at my minimum risk level, then its not worthy of the market.
 

outthislife

Well-Known Member
Thanks for posting this, Jack. Really insightful and intriguing. Would you say that after you began building confidence and issuing dynamic risk, it pushed you through to more success than you initially intended?

I ask because w/ a rigid system, it's relatively clear where one will go if even moderately successful. But with a fluid one, like yours, it'd be less predictable.

Jack said:
I'll do my best, but really this is a subject one could write a book about. :p
Next project?
 

jack

Administrator
Staff member
outthislife said:
Thanks for posting this, Jack. Really insightful and intriguing. Would you say that after you began building confidence and issuing dynamic risk, it pushed you through to more success than you initially intended?

I ask because w/ a rigid system, it's relatively clear where one will go if even moderately successful. But with a fluid one, like yours, it'd be less predictable.

Next project?
I wouldn't say it helped me gain more successes than I intended (maybe I got your wording a bit mixed up,) as I "intend" to always do better no matter what my performance is.

However, I can say it has helped me a lot with minimizing drawdowns, and the impact of drawdowns on my accounts, while still keeping a lot of potential upside. After all, if you're not already in the green on a strategy then you're not upping risk on good setups (and thus your risk is minimal even if it drives into an extended drawdown)...and when you do up risk, it's based on your confidence in the trade instance being head and shoulders above what you'd normally feel for the same trade setup during regular conditions.

I will say, along with the experience trading a given setup, it does take a bit of mental fortitude. If you're the type to revenge trade or abuse leverage after a loss, then giving yourself the "option" to trade more size might not be the best idea regardless of the context. This is why I stressed the experience part, being at the point where you hate risk as a trader and consider risk first, and knowing the strategy intimately.
 

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