In this episode of Truth About FX, Walter digs into timeframes and risk limits. According to him, your risk limits should depend on the timeframe that you are trading. You will also find here a calculator that can greatly hel you in setting your parameters.
Download (Duration: 03:06 / 3.56 MB)
In This Episode:
00:33 – in and out
01:16 – kick in
02:16 – sophisticated
Your set-up and rules should depend on the timeframe [Click To Tweet].
Do you reduce your position size? [Click To Tweet].
Risk is what makes or breaks any system. [Click To Tweet].
Announcer: Sometimes, forex trading is a wild and wooly place to be. That’s why Hugh is here, to post your questions to Walter, the naked forex guy. Hugh’s got questions and Walter’s got the answers. Here at the Truth About FX Podcast.
Hugh: Hi, Walter. Should I set daily and weekly, monthly risk limits?
Walter: That is a great question, Hugh. I think it depends on the timeframe. If you are trading the lower timeframes and you are in and out, scalping or whatever, it is probably going to be daily, one-hour chart maybe, even if you have also daily.
If you are trading 4-hour or maybe daily charts, you can set weekly. If you are trading daily or weekly charts, you might set monthly risk limit. I think what this question gets at is the rules that you set up so that if you hit a certain drawdown or unlucky streak, basically, what a drawdown is if you are executing your system correctly, then those rules have to kick in place.
You stop trading, do you reduce your position size? Do you go away for a while and take a holiday which is the last thing that a lot of people want to do when they are in a drawdown?
They just want to make the money back but those are the sorts of things that will kick in once you hit those drawdown, that percentage. Now, remember, I know it sounds weird but you are actually in control of this because you can set your risk amount so that you are very, very unlikely to hit certain drawdown limits.
For example, if I want to avoid a 20% drawdown — I’ll show you in the shownotes how you can do this — you can go to a calculator and you can calculate that and go, “Okay, these are my system parameters. These are my win rate, this is my reward to risk ratio. What percentage can I risk without hitting that 20% drawdown?” or whatever that number is.
So, you really do control that. I know there are going to be black swans and there is going to be the Francogeddon or the Brexit or your broker gets belly up. Those things are going to happen.
I am talking about within the parameters of your system. I am not talking about sort of outside things that can influence your trading account. That is a pretty sophisticated question.
Sounds like this trader is well on her or his way because when you start getting to this risks stuff, it is something that you do not really think about that much until you get further down the tracks. I am pretty happy to answer questions like this, I guess, is what I am saying.
Hugh: Cool. In the beginning, it is all about systems and risk is boring but once you get into it, risk really is what makes or breaks any system.
Walter: Yeah, absolutely. If you are managing money for people, it is exactly what is going to make or break your clients whether they are going to stay with you or leave. All that stuff is all related to risk so, yeah, absolutely. You nailed it.
Hugh: Great answer. I appreciate it, Walter.
Podcast: Play in new window | Download
Subscribe: Apple Podcasts | Android | RSS
3 Comments (click here to leave a comment)
When you use a calculator to calculate the risk, do you use a zero probability of risk or more than zero? And if more, then what is your threshold for the probability of a drawdown risk?
This is an excellent question.
The solution is of personal choice. Every day in science experiments the experimenters must decide if they will accept a 5% chance that they draw incorrect conclusions, or a 1% chance they draw incorrect conclusions (that is to say, they say that there was an effect for a drug, for instance, when in fact there was not.)
Same thing for testing standards.
Would you buy a car seat for your child that has a 1% chance of failing in an accident, or a 5% chance of failing in an accident?
I prefer to see the threshold at less than 1%, so a trading system that has a 0.8% chance of hitting my “stop trading” drawdown level is acceptable, whereas one that has a 3.9% risk of hitting my “stop trading” drawdown level is not acceptable for me.
Great question, Slava!
p.s. I would add that most traders over-estimate the drawdown they are willing to sit through.