Tag Archives: Stoploss

Twitter poll on expectancy

Trading Journal

I had put a poll on twitter yesterday with options to choose from various combinations of Winrate and Risk:Reward(RR)

Here is the twitter link:

44% of the voters chose Option 4, 32% of the voters chose Option1, followed by Option 2 and Option3 respectively.

Before getting into the groove of things, I would like to elucidate a bit about ‘Expectancy’ of a system. This term was coined by Van Tharp and here it is:

Expectancy = (Win rate x Average winner) – (Loss rate x Average loser)

If we insert this formula with the numbers given in the poll, We get the following –

Expectancy of System 1 = (0.5×2.2) – (0.5×1) = 1.1 – 0.5 = 0.6

Expectancy of System 2 = (0.7×1.2) – (0.3×1) = 0.84 – 0.3 = 0.54

Expectancy of System 3 (I meant to give the RR of system 3 as 1:0.8 but gave it as 0.8:1 – we will stick to what was given in the poll)
= (0.8×1) – (0.2×0.8) = 0.8 – 0.16 = 0.64

Expectancy of System 4 = (0.35×4) – (0.65×1) = 0.75

So, what is this expectancy? Expectancy is how much one can expect to make on the average over many trades. Expectancy is best stated in terms of how much you can make per rupee you risk. Tharp talks in terms of R-multiples but let us just focus on it in layman terms.

If someone risks 1% per trade and their system expectancy is 0.5, it just means that over a large sample of trades, he is expected to make 0.5% (1% x 0.5) per trade. So, if he has 100 trades in a year, he is expected to make (100×0.5%) 50% that year.

Surface level analysis of the poll results

1. It is quite obvious from the above calculation that higher the expectancy, greater is your chances of making money in the markets. So, as a new trader, it is pretty easy to select the option # 4 from the choices. No brainer there.

2. Few people pointed out that Option 1 is better as it is easy on psychology of the trader. It is true to an extent but if one is striving for better risk adjusted returns, option 4 is the obvious choice again (especially for a pure trend follower). Different people, different choices 😊

3. Some people take profits on the way and they would have naturally gravitate towards a better winrate system with lesser R:R. The traders who trail profits will almost always have a lower WR but better RR system in hand.

4. As I always advocate that there are various ways to skin the cat, nothing is right or wrong here. We just need to pick what is comfortable for us. But, if one has to analyse logically, it is option 4. On a side note, one comment mentioned that we need to find system that have a expectancy like the choices mentioned 😊. Fair enough !!

5. The traders who are new to the market gets enamored by the high winrate for a very simple reason – typically, they don’t want to take losses (Forget about newcomers – even the experienced lot do not like to take losses). Their mind can never get around in accepting the losses. So, they naturally gravitate towards high winrate as high WR typically means more number of winners than losers. But, what they forget is the other side of the coin – the Risk:Reward. They lose more when they lose and win less when they win. This has many statistical implications. We will see that in detail in the next section of this post.

6. Winrate and Risk:Reward should be seen together. They are like peas and carrots, day and night – always go together. This is why I like this expectancy as it nicely clubs both the parameters to give a logical view of the system in hand.

7. Few people have voted for option 3 as they feel high winrate can give them the psychological comfort – again, this is just another way of telling that ‘I don’t want to take losses’. As some great trader mentioned. ‘avoiding losses in trading is like you want to breathe in but don’t want to breathe out’. But if it works for you, great !!

In-depth analysis of the poll

1. Most of the stock market strategies employ trend following concept and the pure essence of trend following is to let the profits run. So, the detailed analysis is based on that assumption.

2. First let us dissect what High Winrate really means. Typically, a high WR system will have low Risk:Reward (compare to a low WR with same expectancy). This is a given. But, this also means that the average loser of a high WR system is usually larger than a low WR system(assuming the timeframe and expectancy are the same). In a trend following system, high WR is usually achieved by giving so much room for the market to catch the trend. Statistically, bigger SL will have a huge drawdown potential (am talking about maximum drawdown) and if the max DD is high, it is very difficult to proceed with the system for two important reasons –

a) The recovery factor will be high – meaning the number of trades it takes to get back to equity high(again) will be more and the problem exasperates if someone is trading higher timeframe. People grossly underestimate time drawdown – but it is a different topic altogether

b) Compounding can be a big problem for a system with larger max DD for obvious reasons

3. When a system has a bigger SL (again assumption is that we are talking about pure trend following systems with trailing stoplosses) like a moving average crossover system, the time the market spends between the entry point and stoploss is huge. This has so many psychological ramifications –

a) It can create havoc to our mind as it will feel that we are always in loss (even though it is not realized). One can draw analogy with an investor who enters a stock and the stock is underwater for 2-3 years. It is a very tough phase for that investor if he is still holding it.

b) It can force a trader to make mistakes (not following the plan) and just letting the emotions take the driver seat (how many of us have heard this ‘ I felt uncomfortable in the trade and got out but only to see the market moving in my favor again’). So, wider SL is a fertile ground for all these mishaps in the thought process.

On the other hand,if WR is less with smaller average losses, it will diminish the active trade time in grey area (between entry and SL) and give us a big advantage mentally.

4. Lesser WR and higher RR generally means smaller losses (compared to high WR and low RR/same expectancy system) and consequently, a trader can be well equipped for the proverbial series of losses in a row. One can place large number of bets or trades before we reach out max limit. So taking randomness into account, we give ourselves a fair chance to be in the game. Not to mention, these smaller SLs will also cap the maximum DD and will keep it nicely in control.

The below picture shows the 95% probability of losing streaks for various winrates. Even a 50% winrate system can have 16 losses in a row over 5000 trades. It is not a question of how but it is a question of when.


5. On the flip side, Low WR and high RR will never have even distribution of profits as the system will turn positive only with large profits. If one misses those trades, then the performance would be pretty dismal.

6. The interesting thing is that most of us would feel better with a system that produces more winning trades than losers. The vast majority of people would have a lot of trouble with the 4th system (even though it has the best statistical advantage compared to other systems) because of our natural tendency to want to be right all of the time.

7. As I always say ‘there is nothing right or wrong’ in the markets. We just need to choose what is comfortable for us. The battlecry is ‘how to find the one that is comfortable for us?’. Very simple – try them all with minimum size. Your mind will naturally cling towards the one that is comfortable for you 😊

Happy trading !!

Intraday trading and position sizing

I started this activity to show how we can take a small account to a decent sized account on Feb 5 2018 and we followed fixed position sizing (4 lots) and skipped trades with stoplosses bigger than 20-22 points.

When I traded this system live and took 6lacs to 19 lacs in flat 8 months on compounding, I took all the trades and if SL was bigger than the intended risk, then I would reduce the position size to bring the risk down to the desired level.

On February 19th 2018, I tweeted about reduced position sizing for bigger stoplosses but received several DMs denouncing that idea as few folks are trading with only 1 lot (even though my money management plan clearly stated that we should start with 4 lots). Their contention was that they do not have a way to trade with reduced position size. I thought about it and estimated that we will never come this far w.r.t drawdown (even if we skip bigger SL trades). So, thought to myself that I would stick with the ‘SL too high and so, skip the trade’ logic. Boy, I was so wrong. Big mistake and we are paying the price for that blunder.

Here is the above-mentioned tweet

Just to a give a glimpse of the reduced position size trades and its effect on our net P/L so far. All the big SL trades were profitable trades and that has just increased the mental agony !!

February 2018 – Big SL trades

1. Feb 19 2018 –> Short 10412 (9:50 am) SL = 10451 (39 points) – we should have gone short with 50% position size (to keep the risk percentage constant).Exit at break of 10338 pivot – 74 points profit (for 100% position size). So, with 50% position size, we should have made 35 points profit (after cost on full size).

2. Feb 23 2018 –> Long 10451 (10:30 am) SL = 10418 (33 points) – we should have gone long with 75% position size. Exit at 3:15 pm low 10498 – 47 points profit (full 100% size). Hence, with 75% position size, we should have made 33 points(after cost on full size)

Overall, we missed 2 trades in the month of February because of bigger stoploss. Hence, if we had followed reduced position size logic (the idea is not to miss system trades if SL is big), February 2018 should have been -23(twitter trades points) + 35 + 33 = 45 points.

March 2018 – Big SL trades

1. March 6 2018 –> Short 10375 (2:15 pm) SL = 10406 (31 points) – we should have gone short with 75% position size. Exit at 10260 (3:10 pm bar high) – 115 points profit (for 100% size). Hence with 75% position size, we should have made 84 points (after cost on full size)

2. March 16 2018 –> Short 10315 (11 am) SL = 10345 (30 points) – we should have gone short with 75% position size. Exit at 10224 (3:10 pm bar high) – 91 points profit (for 100% size). Hence with 75% position size, we should have made 66 points (after cost on full size)

3. March 19 2018 –> Short 10181 (10:05 am) SL = 10220 (39 points) – we should have gone short with 50% position size. Exit at 10155 (3 pm bar high) – 26 points profit (for 100% size). Hence with 50% position size, we should have made 11 points (after cost on full size)

Essentially, we missed 3 trades because of bigger stoploss. So, if we had followed reduced position size, March 2018 should have been -104 (twitter trades points) + 84 + 66 + 11 = 57 points.

With this information in hand, it is obvious to see that we should have been up by 102 points in the system(had we taken all the trades with reduced position size) but rather we were down by 127 points at the end of March 2018. A difference of 229 points.

Reduced position size if Stoploss is big

Bygones are bygones. In the first post of this blog, I enunciated how we will deal with this activity and the money required for each lot. Here is the post.

Introduction – Growing small trading account into a bigger one

If we refer to point # 7, it states that “If we look at the Money Management plan that I posted, We have used 40K (including 200 points DD) for 1 lot but are using 50k per lot. We will keep 10k as a buffer amount incase of contingencies. We will invoke the buffer amount if we see unforeseen circumstances.” I believe the time has come to invoke the 10k buffer as we are at 190 points drawdown as of yesterday close.

So, we still have room for 130 more points of drawdown (based on the buffer) and given the fact that the system is faring decently, I think it is time to invoke this buffer amount. So, we will keep continuing the activity (despite numerous trollings and sarcasms hurled on me) until we hit 320 points drawdown. That would be the ‘hard stop’ for the activity. I take complete responsibility for not using reduced position size from February 19th tweet and infact, there have been numerous instances in the past 1.5 months wherein i was advised to take reduced position size for bigger SL trades by my trader friends. Better late than never and i truly believe the error has been rectified now (for the past 2 trades).

Final thoughts

The intention of this post is to elucidate the facts and to see how we can take this forward. Going forward, I will announce the trades as usual in Telegram but if the SL is bigger, we will take reduced position size(as deemed necessary) and 50% or 75% will be mentioned promptly in the message.

Happy trading and have a great weekend ahead !!