Good Questions from the Blog

I received a couple of good questions yesterday that I thought I'd answer before I continue with the multi part post on the gathering and use of statistics.

Nick asked:

Hi EL, Thanks for a great blog! I'm learning a lot.
My question is this - when considering risk/reward, do you think of this in terms of probability or money? e.g. Dalton et. al. suggest a trade should have at least 2 points reward potential to 1 point risk with at least 50/50 chance of success (eg). BUT if you risk say 2 points with a 70% chance of at least 2 points reward (implying 30% chance of 2 point loss), then to my thinking, that is pretty much the same thing - actually better with the law of large numbers playing out. Even with the odds closer to the 1:2 ratio, say 35% loss 65% win with even points, you're still on to a winner until commissions come into play :).
Is this your line of thinking. Sorry if I'm jumping the gun.

Nick, calculating a risk v reward ratio before you have closed a trade assumes that you know how far the trade will go in your favour. Risk/reward described in that way is a myth as, of course, you have no idea how big the reward will be by the time the trade is closed.

Your analysis is half right as far as how I think.

What I do is have a maximum financial loss per trade as a fixed percentage of my account. I then make sure that my first logical scale out point is large enough and has no resistance between that point and my entry. I am more interested in the certainty of the trade (high win rate) than the ratio of my maximum possible loss and the first logical scale out point. I have no problem with a 2 point first logical scale out and a 3 point maximum loss per contract because:

• I have a high win rate
• I usually exit before the trade hits my maximum loss point
• I scale out so my average profit per trade will be higher than my first logical scale out point

Trading is a game of mathematics. My trading structure and methodology has to take into account all these things  to underwrite my consistent profitability.

Then I receives a mail from Todd:

I noticed that in general you do not scale into trades.
Did you have any reasons for this other than the obvious lower average price?
I know of one successful trader that swears by scaling in, but most do not.
Any comments?
Thanks for all your sharing.

Scaling into a trade as it goes in your favour means that you are unsure of the trade. I make my assessment of the trade at the entry and size it accordingly as a 100%, 50% or 25% size in accordance with the trade location and whether I see a possibility of doubling down -typically outside in trades.

Any entries you make in the direction of the trade subsequently are at a worse trade location. Why would you want to do that? I am rather an aggressive entry trader striving to get a good trade location as I know it reduces my risk overall.

The interest rate future, German Bund on Eurex, was where I was trading some of today. There were six nice trades. I was too slow on the range extension break of the ES and missed the trade since there wasn't the usual pullback.