Risk Management 2

Yesterday I said that Money Management questions are dependent on:

  • The volatility of the market.
  • The trader’s Expectancy Return
  • The Ebb & Flow of the market relative to the trader’s trading plan.

Volatility of the market can be measured in any number of ways. For example:

  1. Perry Kaufman’s Efficiency Ratio
  2. Ray Barros’ Ray Clock
  3. ATR
  4. Barros Swing Extremes

The concepts of ATR and Barros Swing are useful in position sizing techniques. The ATR is used in the Turtles’ Position Sizing algorithm and I use the Barrow Swings in my own approach to position sizing – I’ll show how later. The Turtles formula is:

(% of Capital at Risk x Capital)/$ value of ATR = Normal Position Size.

Let’s now turn to Expectancy Return. We shall see how the Expectancy Return plays an essential role in the way I calculate Normal Position Size. The formula can be expressed in at least two ways:

(TotalProfit – TotalLoss)/Total Trades


(Av$Win x WinRate) – (Avg$Loss x LossRate)

I prefer the latter expression because it emphasizes the critical elements in expectancy: the AvgProfit/Loss and the WinRate/Loss Rate.

Finally we have the Ebb & Flow theory: I liken the trader’s plan to a beach front and the market as the waves that flow in and out of the beach. At times the waves will cover the entire beach. At those times we can do no wrong (a time of Flow); on other occasions, the waves will totally withdraw; at those times we can do no right (a time of Ebb); finally there are times (most often), when the beach is partially covered by the waves; at those times, we’ll lose some and win some.

This Ebb & Flow theory explains why newbies blow up. They start trading at a Time of Flow and continually increase their position size; the wave starts to withdraw but newbies fail to realize it, and maintain their aggressive position sizing. The ‘sometimes wins’ convince them that the aggressive position sizing is warranted. Finally the wave totally withdraws and they blow up.

Ebb & Flow plays an important role in my position sizing as we shall see tomorrow.

3 thoughts on “Risk Management 2”

  1. Ray, great job on CNBC! I enjoyed catching what I though might be glimpses of PBZs and PSZs in your chart drawings. 🙂

    Congratulations on your success!


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