Fryers Aggressive Risk Formula

[pkfryer]

I woke up from an unsettling dream where employers were checking my c.v. out for being accurate and I was being found out!! 😈 And I had to earn a living trading because no one would employ me 😱

I had this idea in my head when I woke up which I've called:
Fryers Aggressive Risk Formula

Not sure if this is a good idea or a bad idea. So I thought I would throw it to the wolves and see if you can back test the risk formula to see if it is a help or a hinderance. I have never heard of this formula before but like a lot of novice traders I haven't concentrated on great technical books about money management. So I've made claim to the idea myself.

I think the idea of risk is vitally important so 2% exposion is not to be broken. But imagine if you had £10K given to you for trading and could be more aggressive with it! Its money you really can lose and it wouldn't hurt you if you did. I wonder how many people could really have afforded to lose the money we all have in our early trading exploits!? But if there was money you could lose, you could trade more aggressively with it, slacking up the 2% risk management to maybe as much as a 1/4 of this £10K. So, £2500. If you lose that you can then only risk 1/4 of £7500 = £1875 and so on. So it goes down along with this expendible amount: the aggressive capital. But allows you to have far greater trade sizes, but still keeping the risk contained.

Now, as far as trading is concerned... I had this idea of drawing a stake in the ground maybe every five or ten thousand pounds. £5K if your concervative £10K if you are more aggressive. The capital behind the stake is: safe capital. It is capital you will only allow 2% to be exposed per trade. Anything infront of the stake is the aggressive capital. This is recent profits, money that you wouldn't have otherwise had and is yours to do as you will, i.e. you can lose it and it wont hurt your staked safe capital.

So anything infront of the stake, you can risk up to 25% per trade. So the Fryers Aggressive Risk Formula would be:

risk amount = (safe capital*%2) + (aggressive capital*%25)

The beauity of this formula is that you can be more aggressive with the more 'expendible' capital but keep a close and guarded eye on your safe capital.. the stuff you dont want to lose! The only possible way you can get aggressive capital is if you are profitable as the stake cannot and will not be allowed ever to be moved back! Also, the amount of aggressive capital risked will always only be 25%. If you have a losing streak and you eat into your safe capital (in 2% increments) the safe capital stake point will always remain in place, e.g. balance: £15K, safe stake: £20K. You will only be able to use %2 risk until you regain your original safe balance size.

For more defensive concervative traders: if the account balance falls below the safe stake, risk percentage would be set to only 1%, only rising to 2% above the stake point!

You are being extremely cautious with your safe capital! But much more aggressive with expendible capital!

When your balance hits the next stake advancement, i.e. either £5K or £10K, the amount you can stake suddenly reduces as the entire account is considered Safe Capital.
e.g. up to £29K you could risk (20000 * %2) + (9000 * %25) = (400 + 2250) = 2650.
at £30K you could risk only (30000 * %2) + (0) = £600.
If your very first trade takes you below £30K, an optional protection is to use the %1 risk e.g.
at £29K with safe stake: £30K, risk = (29000 * %1) = £290

My thoughts are that if you have a winning formula that is being profitable but you want to have controlled aggression, you could actually accelerated your profitability by dividing your account up! The image of a safety latch comes to mind, it allows the cog to move forward quickly but wont let it fall back beyond the safety point.

How does this formula sound to you? Would anyone like to backtest it and see what its performance would be like?

Paul

 

[TheBramble]

pk - based on the time of your post is was a real nightmare. As, I'm afraid to say, is the risk profile.

What you have described is pretty close to what most novice trades actually do! But there is less and less distinction between 'safe' and 'aggressive' capital, especially during a losing run when you decide to average down to 'get back your losses'.

You mention something along the lines of 'if you really didn't mind losing it...'. Which I feel is much more to the point. You should only be trading with money you don't need for anything else.

If you need it (or the 'anticipated' profits from it) to pay the mortgage, pay the bills or buy your daily loaf - it's emotional money - you wont trade it unemotionally - and you'll lose.

IMO - All trading capital should be treated as safe capital with less (much less) than 1% of total capital risked per trade. Not 'needing' your trading capital for anything else in life is one thing. Not wanting to lose it is another.

But is was a good idea to throw up for discussion Paul and some of the more aggressive traders may well welcome the concept.

 

[theblackmamba]

imo every trader should aim for a steadily rising equity curve with a minimum drawdown. i have been trading 8 years now fulltime. the last 4 months have been my worst by far, but on the longterm chart of my performance this blip looks negligible, as i risk less than 0.25% on every trade. this means you dont get rich quickly, but you dont get poor quickly.

 

[pkfryer]

mamba, I think thats really good idea. But if you ARE more aggressive but dont want to make blind wreckless risks with your balance I think the aggressive risk formula would allow it. If you want to be aggressive when you have some slack, you could accelerate your profits considerably whilst keeping to a strict risk management approach!

If you have a method thats working you are pretty sure its going to stay working within its previous parameters. e.g. 40% probability, max losers 4, 2x win/loss. With the aggressive risk formula you could give yourself that extra bit of firepower that could produce accelerated profit. The formula will only work when you are profitable, as you cannot apply it until you have reached your first safe stake of £10K and every 5 to 10K of profit the stake is advanced. you are only every being aggressive with recent profits.

If only I knew excel better!! I would love to see what effect this formula would have on real historic trading results! JonnyT.. you fancy back testing the fryers aggressive risk formula on your spot on results?

 

[sidinuk]

I really like the idea, pkfryer. Basically your making sure that you stay in the game and tick over (and pay the bills) with your base capital and then blast away with the surplus and try to build up a much bigger pot more quickly. Eventually you will hit a good winning streak that will take you there but it might take a few goes, in the meantime the base capital is safe (relatively). If you hit a losing streak then you fall back into the safe zone until the good times roll again.

So a bit like putting enough cash on deposit to provide enough income to live and putting the rest into high risk/high return schemes.

 

[JMiller]

PK,

I have though of this idea many times also - though it did not come to me in a dream (or nightmare 😀 ).
The problem with this strategy is that you might find yourself getting nowhere in the long run. Even if you do have a couple of good winning streaks now and again that take you up to the next "level" (ie from 10K to 20K), the age-old question remains:
Who will win the race, the tortise, or the hare?
Would you do better using your agressive strategy, or using a more conservative strategy, risking only 1 or 2% per trade (or less).
I believe the latter....

James

 

[ducati998]

Just a couple of quick comments.

1.....You start with $20K, and you lose 50% of it, what % must you make to return to $20K? Obviously you must return 100%

2..You trade $20K, and return 50%, your bank increases by $10K. You trade 10K, and return 50%, your bank increases by $5K

The point should be obvious, capital protection, capital growth is both difficult and vital to progress towards wealth. There is no such thing as capital that can be casually allocated to possible loss. To believe so, is to consign yourself to the large failure rate within the markets.

The second factor to be considered, is of course the "probability" or success rate of your methodology.
If your probability is "1", then the trade would utilise 100% of your capital.
If your probability is "0", then 0% capital is appropriate. Therefore, an understanding of the true capability of your trading methodology is an important variable to be calculated in the allocation of capital.

The third element is the component of time. 10% in 1 day is different to 10% in 1 year.
Therefore the calculation that I prefer is one that displays these components, and provides me with a ratio.

Let;

G = the expected gain in the event of success

L = the expected loss in the event of failure

C = the expected chance of succss,expressed as a percentage

Y = the expected time of holding,in years

P = the current price of the security.

Applied.....CG - L(100% - C)
then divide by YP,

= Annualised Return

Cheers d998

 

[pkfryer]

The aggressive risk formula would be applied to your recent profit only, the 2% would always be in place with the majority of your account, allowing acceleration as your account grows. With a winning strategy, it would probably continue winning with similar stats in the future. Therefore the risk formula would allow you to make use of more of your available funds. Only those funds in front of the stake line is used with aggression but the remainder behind is still used at a 2% level.

So I believe that it would be the more aggressive formula that would produce accelerated profit rates than the usual standard 2%. Remember, if you do hit a losing streak the amount allowed for risk decreases too, so it actually would take a while to get through even $10K at 25%. With the majority of your account safely tucked behind the stake line untouched. But when you do go back to winning even after a few consecutive losses the more aggressive risk formula would soon make up for any losses very rapidly.

You are right that your account shouldnt be considered as expendible and that is why its only recent profits that are allocated for higher risk. You would never use this formula with anything other than a positive expectation system, one you trust. And if you trust it and its given you consistent profit, why not be allowed controlled aggression and give your system a chance to make better use of the profit that it got for you in the first place? Its a good balance between being aggressive and averting needless risk.

I'll be in a position to back test this formula thoroughly soon, so stay tuned.

 

[ducati998]

pk,
If you return and read your initial post you will no doubt see the contradiction within your last post, viz, the profits are unlikely to represent the percentage of funds you advocate.

There is however a more serious objection to the methodology that you advocate and it is this.
If your trade was guaranteed to be 100% successful, how much of your trading/investing account would you utilise?
If the trade was guaranteed to be 0% successful, how much would you then utilise?
We are of course talking about expectancy, which has an inverse relationship with money management.

Now, assuming, (always dangerous) that you are a "trader" utilising some form of charting/technical analysis, your expectancy, is somewhere around 50%.
This will vary slightly with experience, methodology, market conditions, etc.

Again, assuming that you accept that it is easier to lose money than to win money, why would you wish to adopt an aggressive money management methodology to anything other than a high expectancy trade? Position sizing is one aspect of money management and is only a form of risk control, not a methodology for increasing expectancy.

Now, if your expectancy is high, the next issue would become the number of available opportunities. Very often, as the expectancy rises, so the number of opportunities will drop. The usual response is to lower the expectancy, and increase the number of opportunities, and this may very well result in higher proftability. In this situation a manipulation of money management techniques may very well add to profitability, (adding capital to high expectancy, reducing capital to lower expectancy trades)

Cheers d998

 

[pkfryer]

I think we are talking about different approaches that address a similar thing, increasing the efficiency of a systems profitability whilst at the same time controlling risk.

The problem with the aggressive risk formula is that when you lose you will lose a lot more, but when you win you make it up more quickly, with the overall outcome being accelerated profit. A reasonable string of consecutive losses would damage you, but it would only damage the portion of your account that you are willing to risk in the name of increasing profitability. If you only want to risk 1K, you can move you stake point in $1K increments. If that $1K portion disappears in a freak string of losses the vast majority of your account is safe and limited to 2%, or even 1% if you dip below the most recent stake point.

Controlled risk, whilst increasing aggression. This is an idea that I have performed mental experiments with but have never been in a position to thoroughly back test it, but with a good system I see no reason why it should not give very good returns. I'm coming to the end of coding my own portfolio based, multi-system, money management backtester (and optimiser). I should be able to thoroughly test out most money management ideas very thoroughly in the near future.

 

[ducati998]

pk,
The outcome that all aspire to is increased profitability. There are quantitative and qualitative aspects that must be addressed within an analysis of a position. These analyses must be performed to provide a rational plan.

Now, as you have not corrected my assumption, as you are a chart based technical trader, your analysis is purely qualitative.
Therefore your % success in any given trade is approximately 50/50, with the previous caveats. This expectancy is low. Therefore in a low expectancy trade your money management should be conservative.

Why is this true?
Money management will consist of position size and placement of stop losses. By taking an aggressive position size and or increasing the size of your stop losses, you will increase your loss size. This is not the way forward.
The way forward is to increase the % success rate of your trades. That is to say, move from a 50% expectancy to 70% or better expectancy.

The problem with the aggressive risk formula is that when you lose you will lose a lot more, but when you win you make it up more quickly, with the overall outcome being accelerated profit

As previously stated, if you start with $100, and lose 50%, you will need a 100% gain to return to your starting point. Losing money is much easier and faster than winning money. Therefore your logic is faulty and your premise incorrect.

Focus your attention on tight control of losses, and look for ways in which to raise your expectancy and you will become profitable.

Cheers d998

 

[pkfryer]

Yes I agree with you ducati. You've pointed out something I didn't consider, if you only had a 50% or less expectancy. But you've got to include the win/loss ratio in that equation too. If you have reasonably tight stop losses and have a ratio of winning say 2 times more than you lose, even with a 50% expectancy the aggressive formula will accelerate profitability.

My own preference is towards systems that give better than 50%.

I'm interested in your approach. How do you trade and what would you consider a good money management system that accelerates profitability?

I would have to disagree with you that all traders want to accelerate there profitability, a lot of experienced traders concentrate on reducing risk and letting the profit take care of itself (or there abouts). Thats not my personality though.

 

[ducati998]

pk,
You are now considering the Risk Reward ratio. This of course is an important variable. I believe that this question has been considered on these boards in previous threads, and that is, what is the probability of reward targets being realized?

It is all very well defining a ratio of 3:1, but how often is that ratio achieved? With chart based trading, generally a predefined support/resistance point within a predefined timeframe will provide an exit point, or if a mechanical system, then a predefined exit criteria that minimises the "give back". This presupposes your individual skill in identifying said points, or the robustness of your system.

would have to disagree with you that all traders want to accelerate there profitability, a lot of experienced traders concentrate on reducing risk and letting the profit take care of itself (or there abouts). Thats not my personality though.

Therein lies your answer. Experienced, or profitable traders manage risk correctly. Managing risk correctly limits losses, as losses accrue faster than winnings, winnings will accrue faster by limiting losses. By losses I include costs, transaction fees, slippage, taxes. For small $$traders the % of capital consumed by these costs becomes very difficult to overcome, and limits their ability to succeed. Add to that the desire of many to remove living costs, and the ability to create wealth is all but eliminated.

Now as to how I trade, I am an arbitrageur and vulture investor, that is I invest in bankruptcies,liquidations and various other opportunities (mergers,aquisitions). I do not trade charts etc. All my trades are based on calculated values that allow me to be paid regardless of perceived circumstances by the average investor/trader.

Cheers d998