Adjust your expected reward or die

Quotes Trading ideas

What commonly happens to traders in such an environment is that they will attempt to construct trades with superior reward-to-risk ratios and implicitly set their profit targets too high.  If their entry execution is good, the market will initially move their way, only to stall out and reverse before hitting the intended target.  Hence the frustration many traders feel in a low vol environment:  trades that used to go their way for a profit now fizzle out and have to be stopped for no gain or a small loss.

Something I have been personally struggling with in 2014. The problem is this. Imagine that you are successful only in 30-40% of your trades. These are the trades, where the target reaches minimum 1R. Now in this environment, you cannot simply take the most out of the trade at 1R. Why? Because you would end up losing over the long term since the probability is against you. The minimum should be at least above 2,5R-3R and if the daily ATR is 35pips, you would have to pick top’s and bottom’s,  have a really tight stop to reach max 6R. And I am talking magic here!

The questions is how to solve this puzzle? Find higher probabilities setups and accept lower RR potential. Holding trades over multiple of days. Trading less to earn more. This is something I have been working on lately and so far it is producing better results but I am not there yet to say: I have cracked how to trade consistently every day in these market conditions.

And how are you dealing with current market conditions?

2 thoughts on “Adjust your expected reward or die”

  1. So this was something that I had been dealing with for several years. I could argue that your quote is true in both high and low volatility environments. Most people who start out trading FX learn all the wrong approaches. I’m a great example of someone who spent too much time looking in the wrong direction.

    Most of the reason for this is that there are few educators out there who are actually consistent traders. And fewer still are actually profitable. (In my opinion, they are poor educators as well. They may be funny or good story tellers or well-connected but in the beginning, how useful is that?) If one can succeed at trading with a hard stop so many ticks away, and going for a set multiple of R, then great! But I haven’t met anyone that can do it long term. Such approaches lose their robustness with the slightest change in any one of a myriad of underlying market dynamics. Whether it’s a change in regulation, or a change in correlations, or changes in volatility and “trendiness” — something will ruin those best laid plans. Your equity curve might be humming along for six months, or a year, or two, and then WHAM — your account is down 30% in three months. Or 50%. Because your approach does not adapt with the changes. Or if it does, it does not adapt fast enough.

    So at some point around 2008 or 2009, I changed things up a bit — I focused on “adaptivity” as a core approach, lowered my leverage considerably, reduced my position size to a fraction of what it was before, and began trading as many pairs as I could without carrying too much margin in my accounts. While I have no hard and fast rules about correlations, I pay attention to them. I no longer measure trades in the conventional risk-to-reward terms of a “one-shot-one-kill” approach. Most traders will lose that way, no matter how good they are, because that is just the way markets work. I measure my trades over longer term statistical and fundamental cycles (range and volatility studies, interest rates, macroeconomic trends, relative supply and demand, and the like), with some inter-market analysis factored in as well.

    I will let a trade run against me for hundreds of ticks, then add, then add again, and again, until I am able to capitalize on mean reversion. This means I have to keep my size very, very small, and plan very carefully, given that swings in currencies can be very wide. But the trades revert to mean more than 80% of the time, over a longer period of time than most are comfortable with. For the 20% that are not profitable, I’m able to offset losses with profitable trades and further mitigate by maintaining a positive yield in the basket.

    Given enough time, and enough trades, eventually I am able to build up a book that will achieve about 1.5% to 2% per month with a very manageable drag on NAV during the inevitable draw-downs. (For example, while carrying a NAV that can be down by as much as 5% or more, I’m still booking around 2% per month in realized gains. Annualized, the ratio of max draw-down to realized gains is very attractive.) Over time, 17%-24% p.a. is a phenomenal rate of return — one that most money managers would be thrilled with, but rarely achieve.

    In my opinion, everyone is stuck in a “Van Tharpeian” mindset. I ask: Is Van Tharpe a successful trader? Nope. He’s not. Is Steenbarger? Nope. Look, these may be great guys. They may even have helped a few people. But most will not benefit from what they and almost all other “conventional” educators are teaching. What they teach simply does not work for most. It’s a statistical fact of trading life.

    For me, it is all about leaving that baggage behind, doing the research, and developing a core set of concepts that are robust in any market condition. And knowing that I cannot assume that this approach will work with other asset classes.

    Do the research first. And when I think I’ve figured it out, do a lot more research! This is very important — it usually takes me twice the expected time to gather conclusive evidence one way or the other…and then a few years of actual trading to fine tune my adaptive processes. Currently, this research has me taking profits much sooner, being more patient with entries (i.e. on deeper retracements) and, in many cases, letting trades run against me much more than previously.

    Anyway, this is my journey. (Along with a blown account or two.)

  2. Jay, thank you so much for sharing your story. To be honest, I find it very difficult to go with conventional methods of trading too. Why? Well, let’s face it. I was able to be to consistent in the past but boy, whenever I finally reached the streak of consistency (up to a year), something changed and I felt like I am starting all over again. That does not mean I am jumping from one trading concept to another, far from it, that simply means, that one particular setup i used to trade is either: not that profitable anymore or not occuring that often as it used to and for that reason is not worth my time.

    All my approaches are based on support/resistances. Nothing new under the sun. No fancy indicators. Just price reactions around “key” levels and time. But still, if you add longer time of inconsistency with the emotional baggage which comes with it, you got yourself a south looking equity.

    Something what always surprises me with trading gurus is the lack of transparency. Recently I have asked one of the fx gurus if he knows what kind of max. drawdown I can expect from the type of strategy he was promoting plus some other stats. I was more than happy with majors, or at least one currency pair and sample of at least 200 during volatile and less volatile times. The answer was: “i do not have any hard stats, but i know it works because these patterns are everywhere”.Grhhh, double bottoms and tops are everywhere too, but are they any realiable and offering decent RR, no! Of course I can’t blame it all on markets. I do soo many mistakes each and every day. Trying to learn from them but sometimes it feels like I am just not moving ahead.

    Anyway, I would be interested in hearing more about your methods and research it by myself. If you have any directions you would recommend, I would be thankful for them. I am always on the hunt for a more balanced equity and consistency although I cant quite imagine leaving the concepts I have been building upon for last six years behind.

    Thx again for sharing.

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