Last week was pretty bad. I won a few trades, but at one stage I had six trades open at 1% risk per trade. Five of those trades began to move against me and I was down -3%. Rather than wait for my stop losses to get hit and lose 5%, I decided to close all trades and take a break from trading.
My main goal for the next month or two will be to revisit my systems and see if I can tighten my stops and create reasonable R:R ratios. At the moment, most of my weekly systems use a reward-to-risk of 0.25:1 or less. While it looks profitable on paper, these sorts of ratios present a psychological risk in that when you encounter a loss, that loss really hurts. It would take a relatively large number of wins to claw your way back. Now, when I was looking at the prospect of five losing trades, the psychological weakness of a low reward-to-risk system became really apparent.
The other problem is that because losses are relatively rare, you can't really build a psychological immunity to losing. In contrast, say you have a system that wins 50% of the time, and loses 50%. You can expect a loss when you enter a trade. It doesn't bother you so much because it's well within your system's expectation. On the otherhand, if you have a system that wins 90% and you experience a loss, it puts you on pause. Suffer a few more losses, it makes you question your trading.
Trade management is also becoming an issue. Having five trades move against me at the same time is the result of short-term correlation.
These are new trade management rules that I am contemplating to minimise correlation:
1. Only have one trade open PER TIMEFRAME e.g. I can have one trade open using a daily timeframe system, and another trade on the weekly timeframe, but I cannot have two daily or two weekly trades open simultaneously.
2. Tighten my stops and create reasonable R:R ratios. Tighter stops means a shorter duration for trades, and thus less overlap and correlation. This will also allow a higher frequency of trades.
I will be going on a "semi-break" for the next few weeks at least. I'll continue trading with one trading system that I feel is robust enough (my Hermes low volatility breakout on the daily chart). I'll be re-optimising everything else with tighter stops. This may take awhile. :)
Kevin,
ReplyDeleteWhat might be more helpful than just tightening your stops and changing your R:R ratios is to take the time to analyze your previous trades or backtests.
For instance, you could look into a maximum adverse excursion (MAE) graph. The MAE is basically the largest drawdown during the lifetime of a trade. It will make it much easier to figure out how much unrealized loss must be incurred in a trade before it typically does not recover.
Looking deeper into this might give you better insight on where to place your stops to increase the performance of your trading.
Good luck and let me know if you would like to talk more about this or other ways of improving performance without changing your strategy. (I am a big believer that money and risk management can be as important as entry signals)
I've studied adverse excursions before and tried to use it to optimise one of my systems, but I found it really clumsy.
DeleteMy understanding of MAE is you pre-determine your TP, and then use MAE to optimise your stop loss placement.
Alternatively, you pre-determine your stop loss, and use "maximum favourable excursion" to optimise your TP placement. This is what I currently do.
I'm not sure which way is "better".