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I find that there is a lot of difference between position sizing in futures, and forex. I would like to see if anyone has a clarification of what the proper method for position sizing is for forex.
Let me begin with futures. In the futures market, there is a pre-set tick value. The trader does not have the liberty to adjust this tick value. This is what makes it difficult to take trades with wide stops.It's also what attracts many beginners to scalping since they are able to have a very small risk by doing this. wide stops equal big loss, tight stops equal small loss. There is no other way unless you have a gigantic account size. Let's call this pre-set tick value stop loss.
Now with the forex market. The forex market does give the trader the ability to adjust their position size. In fact, in the forex markets you are able to adjust the position size so much to the point that you can potentially have the same exact risk every single trade. If a stop is very far, or very close you still loose the same amount of money (e.g., 20 dollars) no matter the distance to stop. This is not to be confused with what some trader's do where they put the distance to their stop based off of a dollar value that the market moves. This stop is still a price action stop in nature. The only difference is you always lose the same dollar amount. Let's call this position sized based stop loss.
The only similarities I can find to pre-set tick value in the forex market is have a pre-set contract size, and pre-set max pip loss. For example, a trader will always take a trade with a contract size of 10,000 units, with a stop loss of 10 pips. They will place a price action stop above the most recent major swing. If the distance to stop is greater than 10 pips, they will not take the trade, or will decrease the position size. This is a way similar to pre-set tick value stop loss. On the other hand, If the distance to the stop is small, they will tighten their pre-set 10 pip stop loss value to let's say 5 pips.
I find that this is what makes most sense to use with Al's methods. A pre-set tick value stop loss is what appears to work with actual risk and initial risk as well. This is only under the conditions that position size is NEVER changed. I think that since the position size is always the same, and max loss is always preset, adjusting the pip value would not affect the traders equation.
Position sized based stop loss does not appear to work well with the trader's equation when actual risk is incorporated. It appears that in order to keep the trader's equation constant a trader must use pre-set tick value stop loss. Let's look at two examples.
1) A trader takes a trade with 10,000 units with a pre-set tick value stop loss. They place their stop at initial risk of 10 pips and then when actual risk is obvious they move their stop to the actual risk for a stop loss value of 5 pips.. From there they project their take profit to 2R. Which would be 10 pips. In the end they won. They risked 10 pips, and won 10 pips. This comes out to 1R.
2)A trader takes the same trade, but instead of using a set-set tick value stop loss, they use position sized based stop loss. They have a pre-set risk amount of 20 dollars. They buy let's say.......120,000 units. They place their stop at initial risk with a loss of 20 dollars and then when actual risk is obvious they move their stop to the actual risk for a loss value of 5 dollars. From there they project their take profit to 2R of the actual risk which would give them a profit amount of 10 dollars. This trade,has now become a .5R trade. I don't see how this is a profitable strategy at all. This is under the assumption that the trader will only win 40-60% of the time.
What is Al's take on this? I do not see it mentioned anywhere in the course, nor his website, yet it is EXTREMELY important in the journey to becoming profitable. Should a trader use position sized based stop loss or pre-set tick value stop loss. when using actual risk? Also should they just flat out not use position sized based stop loss at all?
Hi Jesus,
I personally do not see the problem here. Keep it simple. Position sizing is simply matched to your maximum risk acceptable, so you just adjust position size / stop to suit. Does not matter if futures, Forex, or stocks, you just need to be aware of the equivalent tick/pip/pence/whatever the instrument uses and work it out from there. Yes, a little more tricky with multiple contracts/lots but simple math nonetheless.
Al talked a little about position sizing in an old Ask Al audio extract (link below) that might help a little. The topic is spread throughout course in many places, as not considered a topic of its own by Al, except for perhaps 33A - Stop determines position size.
Below an Emini position sizing calculator that you can likely modify to suit whatever instrument you trade.
Ask Al Q&A Extract: Position Sizing
Emini Position Sizing Calculator
Hope this helps if only to start a valuable conversation.
Thank you for taking the time to reply. So you would say that position size is based off of the position sized based stop loss? in other words If a stop is very far, or very close you still loose the same amount of money (e.g., 20 dollars) no matter the distance to stop?
If so the issue can be found in point 2 above. Here it is again.
2)A trader takes the same trade, but instead of using a set-set tick value stop loss, they use position sized based stop loss. They have a pre-set risk amount of 20 dollars. They buy let's say.......120,000 units. They place their stop at initial risk with a loss of 20 dollars and then when actual risk is obvious they move their stop to the actual risk for a loss value of 5 dollars. From there they project their take profit to 2R of the actual risk which would give them a profit amount of 10 dollars. This trade,has now become a .5R trade. I don't see how this is a profitable strategy at all. This is under the assumption that the trader will only win 40-60% of the time.
While I do agree trading should be simple, I cannot find the logic behind using position sized based stop loss and actual risk, in order to calculate profits, at the same time. In the example above, the trader only got .5R...
If a stop is very far, or very close you still loose the same amount of money (e.g., 20 dollars) no matter the distance to stop?
Yes, this is what Al recommends but always, as we all agree, keeping things simple (using defaults help).
2)A trader takes the same trade, but instead of using a set-set tick value stop loss, they use position sized based stop loss. They have a pre-set risk amount of 20 dollars. They buy let's say.......120,000 units. They place their stop at initial risk with a loss of 20 dollars and then when actual risk is obvious they move their stop to the actual risk for a loss value of 5 dollars. From there they project their take profit to 2R of the actual risk which would give them a profit amount of 10 dollars. This trade,has now become a .5R trade. I don't see how this is a profitable strategy at all. This is under the assumption that the trader will only win 40-60% of the time.
Let me see if I can help with this question... when you conclude that your trade became a .5R you are comparing a 20 USD 1IR (initial risk) with a 10 USD 2AR (actual risk). Your thinking looks reasonable: if you win you make 10 USD but if you get the full-blown stop you lose 20 USD. The problem is that this thinking is flawed because you are mixing the two types of risks... and you can't compare apples with bananas 🙂
In your example, if your stop gets hit you loose 20 USD. At that very moment, your initial and actual risks are the same so for your trader's equation (TE) to be good you needed a 40 USD profit target (2AR). This is what you should be shooting at, not 10 USD or any other amount lower than 40 USD (remember that TE gives the minimum, not the maximum).
Rather, if your stop does not get hit and you decide to switch to actual risk (you are free to switch from initial to actual risk), then you forget about the IR and use, following your example, the 5 USD AR, so if you exit with 10 USD (2AR) or more then the TE is fine as well.
So the reasoning should be as follows:
* If you lost: you were shooting for a 40 USD with a 20 USD risk.
* If you win: you were shooting for a 10 USD with a 5 USD risk.
Thank you for taking the time to reply. Your comment helped clear up some issues I was having. Thanks! To extend upon this, I still see an issue with the previous methods for taking profits. Hopefully that can be cleared up as well.
To keep things simple lets use the 20 risk, 40 profit trade scenario. My stop does not get hit and I decide to switch to actual risk, I then forget about the IR and use AR. I set my stop to a loss of 5 USD and reach a profit target of 10USD.
That trade passes and I see another great trade. Once again, I set my risk to 20 dollars, except this time I lose. The previous trade that was a 2R (10USD) profit trade, was all lost in just one trade.
Now imagine this happens again. I'm now down 2R (40 USD). I would have to get 4 more consecutive successful trades using AR with a 10 USD profit in order to get my account flat. I don't know about you, but that souds tough both statistically, and psychologically.
To my understanding, the trader's equation is made to work overtime. I don't see how this will work overtime if AR is used.
Thank you for taking the time to read this.
but that sounds tough both statistically, and psychologically.
In a small sample, one with 3 trades, you can't reach to any statistical conclusion, because playing with the numbers you can get scenarios like the one you are describing (2 big losers, 1 small winner)... or anyone else (3 winners, 3 losers, etc.).
What the TE says is that if you keep doing that eventually you will have a profit. Bear in mind that the fixed actual risk we are using for the discussion is not fixed really, sometimes will be bigger, more close to your initial risk, and some others will be such small that you will not be using it to calculate your profit target.
I know this is not really answering your question but this is what I can say, as long as I have not the math skills to demonstrate the TE's theory!
I only have the TE's experience... when I was starting out, there were things I didn't understand haunting my head. The seemed important but not as important as to learn to read charts and trade so I decided to believe them and do a mental note to come back to them later, when I was profitable. The TE equation was one of them and many years later, now, I really don't care much about it because I know by experience that it works. I never use 2AR or 2IR to exit but I get sure that my profit target (I use PA or fixed points targets) is always bigger than 2AR (or 2IR if the swing is strong) and I am done with it. So my recommendation is to seek for targets above 2AR/2IR and you will see the results coming.
It's been a few days now and I've had the time to think about this subject matter a bit more. Here is my current take on the trader's equation and actual risk. Please let me know your thoughts, and I will end the comment with some questions for you, if I may.
I found that the issue with my thoughts was that I was only looking at risk and gain. The trader's equation has 3 variables, those being risk, gain, and PROBABILITY. When thinking about the trader's equation and actual risk in my first post, I was not factoring in the variable of probability. I now see that by tightening my stop, I also tighten my take profit. Furthermore, I also tighten my stop so it decreases risk if my stop were to get hit. I believe this variable of the probability of the take profit getting hit is what makes the trader's equation work.
I also take it as a method for helping the trader gauge where his actual profit target should be. Sometimes I take trades with huge stops, and the profit target is very far away. With stops this wide it seems extremely unlikely at times that even a 2R profit target would be hit. Using actual risk helps gauge a more appropriate profit target.
I was looking at taking a set profit target of 3R actual risk for now on. This would be used when price action does not allow for a 3R initial risk profit target to be hit, due to being too far for the volatility at the moment the trade was taken.What are you thoughts on a set profit target?
I might be complicating matters a bit here with this question, what are your thoughts with putting stop at break even when price has hit 2R actual risk? My thoughts are that this would further decrease the risk variable in the traders equation. I realize this might just be playing with numbers now 😀
Thank you for consistent responses and patience. Have a great day and take care.
It's been a few days now and I've had the time to think about this subject matter a bit more. Here is my current take on the trader's equation and actual risk. Please let me know your thoughts, and I will end the comment with some questions for you, if I may.
Ok, happy to help!
I found that the issue with my thoughts was that I was only looking at risk and gain. The trader's equation has 3 variables, those being risk, gain, and PROBABILITY. When thinking about the trader's equation and actual risk in my first post, I was not factoring in the variable of probability.
Probability is a fundamental part of the trader's equation (TE). One of the objectives of the course is to teach you to have an educated guess of it so you can plug it in the trader's equation.
If you modify one variable, you affect the others and you have several ways to do it. For instance, tightening your stop and leaving your profit target, you lower your probability. Increasing your profit target and leaving your stop rest, you decrease your probability as well. By how much? This is the difficult question 🙂
Whatever you do, what Al recommends is putting the stop where it should be (do not tighten it too early) and play with the profit target depending on the developing PA.
I also take it as a method for helping the trader gauge where his actual profit target should be. Sometimes I take trades with huge stops, and the profit target is very far away. With stops this wide it seems extremely unlikely at times that even a 2R profit target would be hit. Using actual risk helps gauge a more appropriate profit target.
The trader's equation gives you the minimum target you should be looking for. If you go for more than 2AR you are fine as far as the TE goes.
I was looking at taking a set profit target of 3R actual risk for now on. This would be used when price action does not allow for a 3R initial risk profit target to be hit, due to being too far for the volatility at the moment the trade was taken.What are you thoughts on a set profit target?
When starting out, I would (I still do) stick to defaults because this makes one decission less when trading. Then, while you are in the trade with your default profit target in place, you have plenty of time to compute the actual risk and check if your profit target is >2AR, keeping things simple.
In my case, I only trade the emini so I have 1, 2, 4 and 10 points default targets and deciding one of those is very easy once you see what type of day you have.
I might be complicating matters a bit here with this question, what are your thoughts with putting stop at break even when price has hit 2R actual risk? My thoughts are that this would further decrease the risk variable in the traders equation. I realize this might just be playing with numbers now 😀
Don't ask here stuff that Al will teach you in the course 🙂 There are several videos on stop placement, so use them as your first reference. Here, I always try to give the answer that (I really think) Al would give but I will be wrong, misinterpret or misread so go to the master to find answers... if only you wanna be sure they are correct 😉
Here the problem with your question: there is no right or wrong if you don't provide a context. Context is everything so we can't talk about stop placement "in theory" because you will not be able to apply that in practice. Sometimes context is very clear and other times subtle details can make the difference, this is what makes it difficult!
So no matter what, what you are proposing, reducing your risk (moving stop to BE) but leaving your profit target the same (if didn't exit at 2AR) will make your probability go down. Yet, if you have a TR PA context, rest assured the price will come back to your entry price once went to 2AR, so you should exit at 2AR or even 1AR, and don't allow the MKT to come back to your entry price. Rather, if the PA is trending, many times you can misplace (=tightening early your stop) and the MKT will be forgiving, sometimes will not. Yet, in trending mode, traders allow for the MKT to come back to their entry price once, but not a second time because if so they conclude the trade is not performing as expected and they exit and reassess.
Summarizing: if TR PA, you scalp so you don't need to tighten your stop to BE because you exited with a profit; if trending, you can tighten it after the first test, knowing that you are affecting your probability; and, lastly, depending on context... all the above is false 😉
