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[NAV]

Assuming an account size of $10,000 and average win size of $125, here's how the account would look after 50 trades. I am using the same win/loss distribution among all the experiments below.


Let's assume a lousy win rate of 30%.

Risk/Reward 1:3
Account balance after 50 trades = $10250

The guy loses on 70% of his trades and yet remains profitable


Let's assume a 50% win rate

Risk/Reward 2:1 = $4875

Risk/Reward 1:1 = $9000

Risk/Reward 1:2 = $13125

Risk/Reward 1:3 = $16750

The guys with 2:1 risk/reward never make it in this business. They are the ones who are in the business of making their trades succeed, not making money. Yes the guy wins 50% of his trades, but has his account cut in half after just 50 trades. The guy's TA is pretty good, but is a lousy money manager.

The guys with 1:1 risk/reward are the ones are those who always wonder why their account never goes beyond breakeven, although they have a good trading system and they are doing everything right in the world.

Clearly the guys who make it are those who go for at least 1:2 or 1:3 risk/reward


Let's assume a 70% win rate

Risk/Reward 2:1 = $8500

Risk/Reward 1:1 = $12750

Risk/Reward 1:2 = $17000

Risk/Reward 1:3 = $21,750

Here's a guy with a spectacular trading system with 70% win rate. It's as good as it gets in this industry. Woudn't it feel disgusting when the guy plays for a risk/reward of 2:1 and manages to lose money in the end with such a good win rate. These are the same folks who use a 10 point stop on ES and go for 5 points profit. Ain't gonna work.

Intersting fact is even with a win rate of 70%, the guy playing 1:1 risk/reward won't make as much money as the guy with 1:2 risk/reward and 50% win rate.


90% win rate

Risk/Reward 2:1 = $13250

Risk/Reward 1:1 = $14250

Now if you have to stay profitable with a 2:1 risk/reward, get this - you can do it with a 90% win rate. I haven't come accross a mechanical system with that kind of a win rate. One needs to be highly selective about trades and go for a low risk/reward to achieve that kind of a rate. That also means a lot of good missed trades.

Even with this genius of a trading system, the guy playing 1:1 risk/reward cannot beat the guy with 1:3 risk/reward and 50% win rate.



The reason i am posting this is, i keep hearing about how big money is made by sitting on trades for ever, without no one ever mentioning risk and money management. It all boils to one thing in the end. What is your risk/reward ?. Now i know of many traders on this board who never closed their longs during the Jul-Aug 2007 decline, but now come and claim victory. Well first of all, congrats for having emerged victorious and having a steel of a stomach to endure that decline. But here's the question - why did one sit thru such a brutal decline ?

Possible answers

1) They are buy and holders like my dad and mom, who don't know anything about technical or fundamental analysis - obviously traders on this board don't belong to this category, since most here are informed traders and technical analysts.

2) Their market timing sucks - may or may not be true. If their market timing sucks, then they have no business claiming victory. Since they are claiming victory, then this assumption must be false.

3) This leads us to the third conclusion. They are capable of accepting large drawdowns to ride the larger trend. So if a guy did not close his positions at SPX 1555 and took a nearly 180 points drawdown, that means he must be exepcting a far larger return on the upside than the drawdown. As we saw above, anyone playing less than 1:1 risk/reward ain't gonna hack it in this business. Again i am using 180 SPX points drawdown, since it's now clear in hindsight. But the risk was open ended before Aug 16 and there was also a possibility of crashette and the financial ruin for a trader without stops.

Even proceeding with the 180 point drawdown fact, the guy expecting a 1:1 risk/reward, should be expecting SPX to reach at least 1555 + 180 = 1735. Today we are at 1560, which is 5 point above where we were before that huge selloff, but you see guys who sat thru the entire decline claiming victory on their trades.

Is it ? - thank god, i am breakeven. Uh, that was a wild ride. I will never do that again !
Or is it ? - Look i sat thru that 180 point decline, but now i am profitable a whopping 5 points ! Wheee !!.
Or is it ? - Ok, i am now back to breakeven. The fun has just begun. Watch the sky !


Some could argue that the drawdown was on open profits since they were long from 2003, so it doesn't matter. That's the biggest baloney i keep hearing. Now a guy could have said, look i have been long Nasdaq since 1997 and with this 2000-2002 drop, i have only given back my open profits and ain't lost anything. Without treating the house money as one's earned profits, one can never be profitable. If giving up one's open profits is a valid argument, then why do we come and talk about our TA skills and market savvy on this board ? Then how are we different from those folks who know nothing about the market and ride these ups and downs of the market in their retirement accounts over decades, without any TA skills or market knowledge ? At least, they are modest and don't attribute their account growth to their TA skills.

So it is either 2) or 3). Since it's not 2), it must be 3). If it's 3), i think it's too early to celebrate. Wait for at least SPX 1735. Again, i am not critiquing anyone here. I get a chuckle when i read some posts about how big money is made, while the objectivity is far from that perception. Money mangement is the least understood and least sexy subjects out there. Talking about melt-ups and crashes are more sexy and that's what brings fame. Sorry for the rant....

Edited by NAV, 10 October 2007 - 07:14 AM.

[skyymaster]

Thank you for bringing up this subject. Perhaps we should posts more real experiences about how one made a successful stop loss trade to drill the idea of money management into our heads but as you said it is a subject people hate and probably busts some EGOS. I have learned to place contingent orders where if the price hits near my stop loss target then stop loss order is triggered. This way the market does not know where I put my stop loss from the get go. Many put theirs around support and resistance points. Market knows this and they get executed. I been reading some stuff about not fighting my self so that I can open my self up to more opportunities. I am sure everyone knows, but we forget - trading psychology is a must. Someone here posted a great link to the this article which has really helped me to study myself. Here is the article FWIW ===================================================================== A scorpion and a frog meet on the bank of a stream and the scorpion asks the frog to carry him across on its back. The frog asks, "How do I know you won't sting me?" The scorpion says, "Because if I do, I will die too." The frog is satisfied, and they set out, but in midstream, the scorpion stings the frog. The frog feels the onset of paralysis and starts to sink, knowing they both will drown, but has just enough time to gasp "Why"? The scorpion replied softly and calmly: "I can't help it, it's who I am, it's my nature., it's me being me."…from Aesop's Fables No matter who you are, how intelligent or how much education you have, if you keep doing the same thing over and over again, expecting different results, you are suffering from the most insidious form of insanity. This is self-delusion of the highest degree. Many years ago, when I first started to trade, I was so optimistic that I could make money consistently. I was smart, more educated than almost anyone I knew, a successful brain scientist and physician, and always had been able to study hard and master anything I put my mind to. I could do it and nothing was going to stop me. I would work longer and more intensely than anyone else, and show wonderful profits month after month. Little did I know what I was facing, and that I was about to come head on with the most challenging task of my lifetime. Simple, maybe, but not easy. Not easy at all. After a few months, I found myself dancing as fast as I could, yet running on a treadmill going nowhere and suffering from vertigo, headache and a severe case of tick-itis. I studied and read everything I could lay my hands on, subscribed to service after service looking for the Holy Grail and struggled to make consistently successful trades. Why couldn't I do it? What was wrong? Is this so difficult? What about all the people who have returns of greater than 80% a years? They couldn't be exaggerating, could they? After all, it's in print and on a heavily subscribed website, so it must be true. Mustn't it? So I studied more, subscribed to more services, learned new indicators, bought books, joined some chat rooms and saturated myself with information. This produced more vertigo, headache and sleep deprivation. I was on total information overload. I started sleeping sitting up so that I would not sleep too deeply and could awaken more easily at 4:30 AM (having gone to sleep at around 1:30 AM) in order to study and watch the markets before they opened at 6:30 AM. I was in total immersion, so why couldn't I make consistently successful trades? I became paranoid, thinking it was a kind of conspiracy since every time I took a position it went against me. I knew the stop and was stopped out in my minds, but we didn't take the stops because I had faith that the position would come back. It was some kind of a misunderstanding or misinterpretation by the market that was responsible for the price spiraling downward. Buy more. That's it. Average down and keep averaging down and eventually, I will get it right. Eventually, the price will come back up and I will be justified. Why isn't the price coming back? I know it has to. After all, I studied it, charted it, listened to the gurus, read everything on every bulletin board, and it absolutely has to come back. Oh, that news that just came out… Ugh! Must be false or overstated because there is no reason that the stock should be selling off like that. I know it is coming back, so I will buy more. Wow! Look at the size of the position now. Hmmmm. I better kick it up a notch and start participating in every message board and study every report and watch every tick every day for signs that life is returning and I can get back from underwater. Most of you know how this feels. I do. I have been there, lived it, and suffered losses from it. Life was miserable this way. I became depressed and irritable. I walled myself off from the rest of the world just trying to figure out what to do. I had dug a really deep hole and the only way out was to sell and take the losses, or waited and be in agony day after day, watching my account and my self-esteem (what was left of it) erode like sifting sands. I tried too hard, studied too much, and pushed myself to the point of both physical and mental exhaustion. Why? Why did I not honor the stop, continue to hold on and even average down? I had to figuratively kill the frog and kill myself in the process. In order to be reborn, I had to destroy the internal self-defeating programming and start all over again. I had to step back, look at what I had done with a sharp and penetrating glare in the bright light of day. I decided to take the loss, to stop trading for a while, to take a vacation and center myself. My health returned. The dizziness and headache went away. I didn't care so much about watching the flickering ticks (so, at least, I was in remission from a severe case of tick-itis). It was not the market, the charts, the software, the gurus or anyone/anything else. It was me! I was my worst enemy. Nothing was going to change until I got right with myself. Janice Dorn

Edited by skyymaster, 10 October 2007 - 07:56 AM.