Risk Management V

BarroMetrics Views: Risk Management V

I  was going to write a post on the elements of a robust trading plan. But given the questions from Baz and Paul, it;s clear that the questions have now coalesced around the Expectancy Return Formula.

As I see it, Baz is most keen to have some idea of how to identify an Ebb and Flow Phase.

The answer lies in our trading results. I calculate what, based on past trades, will be my losses within a 70% occurrence. I do this using Steidlmayer’s idea on how to calculate a Value Area (see attachment). The reason I use Pete’s approach is because the normal bell curve assumes a distribution where the mean and mode are roughly in line. This is not the case for trading results.

Once I have the data, (generally) if I find that I have three consecutive trades with losses outside my ‘normal’ range, I start to reduce my position size. In short, three losses moving into the beginning of the second standard deviation of greater than normal losses triggers a reduction in position size.

As for profits, I first calculate the numbers for profitable trades. With those in hand, for Flow stage. I prefer to see three consecutive trades where I have profits are in the upper region (or higher) of the  second standard deviation.

I’ll deal with Paul and Manish’s questions on Tuesday.


Through the courtesy of www.marketdelta.com 

4 thoughts on “Risk Management V”

  1. Thanks Ray, could i check if i have grasped correctly. say you lost 10 trades in a month, the next months mean would be 7 losses? If so, then at say 8th loss, you then go into ebb mode and reduce lot sizes. Until a return to mean? And would you start to reduce if say your winners started to exceed the winning mean? based on monthly figures?
    Furthermore would you the correlate the ebb and flow data with your journals to perhaps enable you to shed light on a possible cause for the ebb or flow. Am i on the right track. thanks for your insights cheers Baz

  2. Hi Baz

    For me, it’s not the number of losses but the amount being lost as measured by the expectancy formula.

    Yes, in my psych journal, on a monthly basis I note whether I believe I am in Normal, Ebb of Flow.

    I also make a note if I deem I have dropped below acceptable consecutive expectancy returns.

  3. Dear Ray,
    I admit that i am lax in writing a trading journal. From the above discussion i deem that once you have ‘n’ number of losing trades in a row you deem to be in ebb state so you reduce your position size. If you are making money then you are in a flow state.

    But is not ebb and flow state a function of how you are reading the market. Say I am bullish in market and i take three-four long trades… market goes my way and I am happy. But then I am still bullish and the market goes the other way and i lose a bit of money. So where does this ebb and flow state fit in.

    Either I am on the right side or I am on the wrong side. If I am on the wrong side I will just close my long trades at a predetermined level and then reassess if I want to be in the direction of the trend or go the other way.

    Sorry If I sound ignorant on this topic. I will start maintaining a psycho journal and trading journal from today.


  4. Hi Manish

    No apologies necessary.

    The point I was making in this blog was that it’s not just the number of losing trades; it’s the expectancy return on the losing trades.

    In your case, it sounds as though you are trading a mechanical system. By definition that will have a range of negative expectancy return.

    It’s when the system starts having expectancy results worse than your test results that you need to re-look at the system.

    It may be, for example, that your system requires a certain volatility and the current volatility is too low or too large.

    Or you have a trending system and currently the market is in a congestion mode etc….

    Whatever the reason, when in ebb phase, you need to reduce position size.

Leave a Reply

Your email address will not be published. Required fields are marked *