Thinking ‘Three Moves Ahead’ IV

We are talking about the impact of time on trading. In my last blog I spoke about using time to manage our trades. In this blog, I want to consider the impact time has on risk.

I use the 18-day swing as my trader’s timeframe i.e. the monthly trend defines my strategy: ‘long’, or ‘short’, or ‘stay out’ if I am unclear if my trader’s timeframe trend is likely to continue or change. I hold my winning positions for a mean of 29 days, with a standard deviation of 17 days. I fully realize that the longer I am in a trade, the greater the probability that an adverse Black Swan event will occur.

To reduce this risk, I have certain minimum profit parameters that must be achieved for me to retain the initial size. Unless these targets are achieved, I start to reduce my size. This reduction can be anything from total exit to a 10% reduction: it’s all a function of how far the market has moved in my direction in the time under consideration.

Sharing my numbers would not serve any purpose because the reduction in size and the time I allow is a function of our trading results. But, I can share the factors I take into consideration.

  1. The type of setup for the trade: negative development or contraction or other.
  2. The instrument (I have found that each instrument has its own characteristics).
  3. The Maximum Adverse Excursion in Time and Price: On my results, how long do I normally hold a trade that has eventually resulted in a profit? On my results, how far has the market moved against me and has still resulted in a profit?
  4. On average what is the normal profit for this setup and what is the normal profit per day?

Items (2) and (3) provide me with good estimates of the probability of eventual success. Let’s say the market has gone against me by mean +2 in both time and price. In addition, let’s say the average profit is 12% ROI at a daily rate of 0.5%. The trade has had a lifespan of say 10 days. So if everything were proceeding normally, I could expect a profit of about 5% (10 x 0.5%). Suppose my profit is only 1%; in this situation, I’d exit the trade or at least drastically reduce my position size.

Do I miss out on some profitable trades? Sure I do; but most times I lose only the difference between my exit and re-entry. But what is more important is I miss out on quite a few large losers.

Notice that this is different from grabbing profits just because they are there to be had.

Let’s say in this trade I have achieved a core profit of 12% in a shorter than normal holding period, and let’s say that my Primary Zone exit would yield an 18% profit. In this situation, I would resist the urge to exit with a view to re-entering once the ‘inevitable correction’ is over. The problem is in the best trades, there is no correction and generally, in these cases, the market does not provide a low risk re-entry.

So, I use time to assess when the probabilities cease to favour the trade; if the trade is performing as I expect i.e. it does all I ask to remain in the trade and does not exhibit any signs that would cause me to exit a trade, I will hold the position.

Tomorrow I’ll consider the role of luck in trading.

3 thoughts on “Thinking ‘Three Moves Ahead’ IV”

  1. Dear Ray,Would i be near the mark in assuming that this is a similar entry to the turtles but with a tighter fiscal policy as to secure some profit.The turtle model appears a little wasteful at first glance and possibly your system addresses this as well as being able to capture the big moves when they occur,which seems to be at the heart of the turtle system. cheers baz

  2. Hi Baz

    Thanks for your comment.

    For me, this post is not about entry but about reducing risk (position size) as time marches on. If the market does not reward me with profits, then I am seeking to reduce my exposure.

    The Turtle entry was a breakout channel system whereas my preferred entry is to buy on weakness in uptrends and sell on rallies in downtrends.

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