8 Days of Pain
One of the most enduring trading debates concerns the ‘best’ reward:risk (R:R) to aim for. My answer to that is as obvious as it is boring (the one that maximises profit for tolerable risk) but that won’t fill much of this white space. So lets instead look at one argument for lower R:R.
Two traders, A and B, have exactly the same expectancy per trade (5%) and make exactly the same number of trades per day (5). They will, over the long term, make the same amount of money.
Trader A is happy to take trades with a R:R of 2 but Trader B holds out for 5. With the same expectancy Trader B has a much lower win-rate than Trader A but that is OK because he makes more when he does win and this balances out exactly. Mathematically they are similar, but practically there is a big difference.
In a typical month of trading Trader A can expect 2 days where every trade loses, Trader B however will experience 8 of these days. That is a lot of pain in terms of draw-down and, if Trader B has emotions(!), a lot of emotional pain as well.
I am not defending low R:R systems, I am just adding some numbers that demonstrate how increased R:R markedly increases variance and pain. If you are only bothered about the average annual profit then you can ignore this, but if 8 days of pain a month sounds intolerable then this might give you cause for thought.
I’m not even going to mention that The Gambler’s Fallacy shows us that after a losing day the probability of another losing day remains unchanged and, for Trader B, depressingly high.
This is the reason I moved to targets rather than a technical exit.
Letting your winners run will make you more in the long run but the EP is high.
When I looked back on my trading month there would be one or two trades (whales) that made the whole month, however If you missed one of those for whatever reason……
solfest
June 28, 2010 at 2:04 pm
I do though miss the positive spin I used to put on the ‘high R:R problem’ you identify… “I may as well take the day off as I’m probably only going to miss losing trades, basically I’m getting paid to go to the pub…” etc etc.
long&wrong
June 28, 2010 at 11:37 pm
I have high threshold for pain.
I shall persist…..
after I figure out my expectancy….
Jules
June 29, 2010 at 7:14 pm
I’m a masochist. I look only at risk, and try to maximize that. And I let it run, and run and run until I see that it has past its maximum point of reward. Then I watch as it plumments and plumments, until any more pain would be unbearable.
I smile. And repeat.
Risk. My friend.
Masochist
June 30, 2010 at 6:46 am
Masochist – there are some *really safe* mortgage backed securities that would suit you down to the ground
long&wrong
June 30, 2010 at 2:51 pm
[...] personal experience is that losing days are regular (I take 35+ trades/day. The more trades and higher WR%/ lower RR then the lower the daily variance), losing weeks are rare and losing months are almost [...]
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