Knowing Your Total Risk And Possible Losing Streak


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If you ask a novice about the most important part of their trading plan, they will talk about their percentage return and the millions they are going to make in the markets.  If you ask a seasoned hand about the most important part of their trading plan, they will talk to you about Risk.

Risk is the single most important thing when trading and investing in the stock market.  You see countless quotes from billionaires and multi-millionaires about risk, and tellingly enough, virtually none about the future or predictions:

“Rule one of investing: Never lose money. Rule two of investing: Never forget rule one.”  Warren Buffett

“Take care of the downside, and the upside will take care of itself.” Donald Trump

And while there are thousands more gigabytes of data and information freely available to us as traders or investors now than there were 100 years ago, the most important thing is not the latest fancy indicator or the live streaming data of overseas markets.  It’s Risk.  Plain old boring Risk.

What Is Risk To A Trader?

Risk from a trading point of view is usually defined as the difference between your entry price and your stop loss.  Yes, that means you should have already set a place when you enter a trade, that you will get out if the trade goes against you.  As we discussed here, knowing our risk and how much we are risking per trade is very important.

But that is just the beginning.  In this lesson, we’re going to take it a step further and look at possible losing streaks, and also our total risk in the market.

Win Percentage Is Important Here

Knowing your trading plan’s statistics is very important here, because your Win Percentage has the power to affect your probable losing streak in the market.  Your Win Percentage is the amount of times you win, divided by your total number of trades, giving us a percentage, such as 65%.

Once you have the current win percentage of your trading plan or system, then you can look at the table below to get a feel for what your possible losing streak might be.

Of course, you may never experience a losing streak like this, but mathematically it is possible, so we must always look after the downside and be prepared.  This is also why it is important to be able to take small losses in the stock market and not let them turn into big losses.  Can you imagine one of these losing streaks while losing 10% of your portfolio each time?  You wouldn’t be around in the market very long trading this way.

Knowing Your Total Risk or “Portfolio Heat”

If we are going to look after the downside when trading and investing, we should always know what our total risk is.  To do this, we can add up our total Risk (using a simple Excel spread-sheet is an easy way to do this), listing all our positions (for example we might have 10 open positions), and the difference between our entry price and our stop loss.

Another way to look at it is the difference between the current trading price and your trailing stop loss – this will give you the potential draw-down from your highest equity point.  This is also known as “Portfolio Heat”, where if all your positions were stopped out tomorrow, you would be down by that much.

It is generally accepted in the markets that most traders find it difficult to go through a 20% draw-down or loss in their portfolio, despite thinking that they should be able to handle it, so be cautious if your portfolio heat becomes too large.

Table Of Possible Losing Streaks

The table of possible losing streaks below is based on a 10,000 trade sample size, which should cover most traders or investors over a decent period of time.  Obviously, the larger the sample size the better, and increasing the sample size will increase the possible losing streak slightly.

                    Win %               Possible Streak
                     30%                         26
                     35%                         21
                     40%                         18
                     45%                         15
                     50%                         13
                     60%                         10
                     70%                          8
                     80%                          6
                     90%                          4


As you can see, having a losing streak of between 10 and 15 at some point in your trading career is quite probable, and something you should be prepared for.

If you are doing automatic back-testing with a program like Amibroker, then it will often give you these statistics automatically, along with your maximum draw down (MDD) and win and loss percentage.

Knowing and accepting the down-side in trading or investing is essential if you are going to have any longevity in the markets.  If you combine this with optimizing a trading strategy using in-sample data and then testing it using out-of-sample data, then you could have a more robust strategy that has the power to see you through good markets and bad.

And there will be plenty of both on your investing journey!

Happy trending,

Dave McLachlan

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Other Lessons in the Free Trading And Investment Course:

  1. What’s Your Trading Or Investment Personality?
  2. The Simple Mathematical Tool That Creates Millionaires
  3. Following The Smart Money In The Market: How To
  4. Using Trend Lines To Enter And Exit A Stock For A Profit
  5. An Amazing ”Stop Loss” Anyone Can Use To Increase Their Safety
  6. See Also: Coding a Moving Average system in Amibroker
  7. See Also: Coding a Bollinger Band Breakout in Amibroker
  8. Contingent Orders and Trading When Working Full Time
  9. Position Sizing: Thinking Risk Instead of Percentage Return
  10. Getting Your Stats: How To Know If Your Strategy Can Win
  11. Knowing Your Total Risk and Possible Losing Streaks
  12. The Everlasting Lure and Terrible Dangers of Predictions
  13. The Top Six Account Destroyers and How To Fix Them
  14. Final Thought


July 7, 2013  Tags: , , ,   Posted in: Articles On Building Wealth

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