Some of you may have noticed me go from +2 scalps to +2.5. This represents a shift in my risk management strategy that was under extensive testing. Previously, I have posted a risk management system that could be used by traders to take a moderate fixed profit with a small fixed risk.
That system works because every win is larger than every loss and a breakeven trader should still accumulate points. However on some days such as today, the price action obviously favors swinging your position.
Traders who wish to swing should use the following risk management strategy. This strategy is methodology neutral, i.e. it should work with any kind of trading/entry system.
- Initial Stop is -5t for full size.
- 1st target is +10t for half size.
Never loosen or tighten the stop until the first target is filled or stop is taken out. If not, you lose the benefit of the math. When first target is filled, move stop on balance to your entry price and let it run. The swing portion can be exited at any price above your entry price but you should try to get at least 4 points.
In the breakeven case:
- 50% of trades stop you out without filling first target. (10t loss)
- 50% of trades fill first target and pullback to take your breakeven stop. (10t profit)
This means even if you can never ever swing a trade, the worst you can have is breakeven as long as your win-rate is at least 50%.
If you can manage to keep your win-rate above 50%, your account should slowly accumulate winnings. You can do the following to keep a better than 50% win rate:
- Trade only after an obvious trend has broken out.
- Trade only deep pullbacks in the trend.
- Never take reversals.
- Extreme caution between b24 and b60.
- Avoid poor signal bars (overlapped, tails, too large, wrong color, etc.)
If your win rate is less than 50%, just stop trading anything else except an obvious trend and first get above 50%. A win rate under 50% means you are doing something very very wrong.
They way you structured this post it sounds like you are saying that a random entry trading system will win if you use the exit strategy you described.
ReplyDeleteWhen you say "it should work with any kind of trading/entry system" you may lead people to believe they can be profitable if they use the risk management strategy you describe. Hopefully you can clear that up on your next post.
No, I said they should be breakeven if they use this strategy with a 50% win rate regardless of the system including random entry, i.e., tossing a coin: heads = long, tails = short (not recommended, of course)
DeleteThis is a mathematical statement, not a technical analysis statement. i.e. 50% at -10t and 50% at +10t = breakeven.
If they are using price action entries and are already better than 50%, then they already have a positive expectation. This strategy enables them to swing as opposed to taking fixed profits.
To clarify, if you try this with a setup thats less than 50% such as fading trends or trading chop, the math will obviously work against you.
DeleteHi cadaver, I just wonder why bar 4 is not a fBO setup? I thought in you chart setting there are several marks of fBO for the similar pattern.
ReplyDeletefBO represents an attempted trend breakout from a trading range. If you are obviously already in a trend, then the likelihood of it being a pullback are far higher. The first three bars obviously represent a trend from the first bar since they are all non-overlapping trend bars.
Deletethanks. I saw sometimes you take 4 pts and sometime you take 2.5pt for the 1st half position. Is there any principle there?
DeleteCad a 5 tick stop seems very small, did you testing show that over the long run it was the best size? Thanks
ReplyDeleteFor price action entries for a signal bar with strong close after deep pullback near a support, I have extensive data to show that a 5t pullback is sufficient as long as the signal bar is not overlapped heavily. If the signal bar is overlapped (including inside and outside bars) you would need a 6t stop. I'll address this in a separate blog post.
DeleteCad
ReplyDeleteIf risk is 5ticks and (1st) target is 10ticks, and you have a 50% win rate, what is the reason for not exiting the entire position at 10ticks? Why scaling out and being happy that you are already breaking even at worst, and why not taking your entire profits and enjoying consistent profitability...? Let me know if I am missing your point. Also, your last sentence is a little bit hanging in the air. 50% win rate of what kind of R/R trades...? Are you really suggesting to your readers that it is extremely easy to reach 50% win rate with trades that go either 5 ticks against you (1R losers) or 10 ticks in your direction (2R winners) and anybody who hasn't achieved this is "doing something really, really wrong"? I hope not.
In my post Two Strikes, I describe a strategy for exiting the entire position and on many days, it may be the best option. However, on many days when you have an expectation of the move running many times beyond your initial target (often 4x to 10x more), you should have a way to let your winners run. And this is an approach to do that with breakeven odds.
Delete50% win rate enables you to manage risk effectively. Every trader should try to get there. If your trades are less than 50%, wouldn't you be better off fading your own setups?
Your question regarding 50% on 5t is well taken. I'll address that issue in an upcoming post.
This comment has been removed by the author.
ReplyDeleteHi Cad,
ReplyDeleteWhy not using signal bars' bottoms/tops for your stops (and scaling out take profit targets respectfully) as Al Brooks recommends?
I wonder how you will be trading days with 5pt or 50pt trading range using your strategy?
Thanks a lot for your educational efforts.
Alex
You can certainly do that, but your risk is uncontrolled. For some signals its 4t for some others its 12t. Mentally, many traders wont be able to hold through a pullback that they are not used to. i.e. a 3pt stop may seem ok on a 2.5pt bar (very routine) but most traders wont be able to hold through.
DeleteThe ability to hold through a trade without going through severe emotional distress is very easy if you risk the exact same amount every time. Next, focus only on setups that are not expected to pullback beyond that amount.
Hi cadaver,I saw sometimes you take 4 pts and sometime you take 2.5pt for the 1st half position. Is there any principle there?
ReplyDeleteIn general, if I enter after a reversal or a pullback right after a reversal or if I believe the chances of a pullback after an initial push are high, I will take +2.5. If I'm very confident of a strong move, I will raise the target to +4 or even more.
Delete