Imagine a game for money, in which a bag of marbles backfilled, 60% are white. If you got a bag of white marble, then win the bet. The remaining 40% of balls blue. If you take out a blue ball, you lose something that risked. Waiting for this game = 20? It is true to a long series of games you make 20 cents for every dollar risked. This is much better than any game that you might find in Las Vegas. But what percentage of people who play it make money?
I represented many times in this game talks, seminars and conferences. We usually do not play for real money, but the winner (ie the one who will get more than just "money" after 50 tries) was rewarded. Typical results - a third of the audience loses outright, another third of the money lost and only a third of the participants can earn something. And these results are not unique.
Ralph Vince, the author of three books on money management, suggested that 50 doctors of philosophy, who knew nothing about money management and statistics, to play a game similar to the above on 100 attempts. They had no incentive to win (which could provoke imprudent behavior.) They were only asked to make as much money. Guess how many of them have made money at all? Only two, or four percent, were able to make money!
Usually, except for complete ruin, it turns out many different options for the game, how many people were in the audience. But they all start with the same amount of money and everyone gets equal treatment (ie, beads). But in the end there is a difference between the results. Why? Poor position sizing and undisciplined psychology. If people can not make money at 60% of th system of marbles, what are their chances to earn in the markets? Minimum!
There are three factors that determine victory: (1) system with a positive expectation, (2) position sizing and (3) individual psychology. All three factors are usually ignored on the average trader. To show why this is so, I would like to discuss the psychological propensities arising in people in the development and use of the system with positive expectancy and position sizing, rather than to talk about psychology as a separate subject.
Traders do not understand what the system with a positive expectation
Most of us have grown under the influence of an educational system that imposes on us the firm conviction - to be the best, you need to 94-100% of cases are right,. And, if you can not be right, at least 70% of you - loser. Mistakes are severely punished in the school system ridicule and poor grades.
By contrast, real-world hitter in baseball, only a few shots that are successful will receive millions. In fact, in the everyday world few people close to perfection. but most of us do a good job, is likely to be right less than half the cases. In fact, people have made millions on trading systems with the reliability of 30-40%.
Jack Schwager in The New Market Wizards quotes William Eckhardt, that most undermines the behavior of the average trader is the need to be right in the current transaction. This one factor destroys most of us when we try to beat the market.
Because of this factor, people are constantly looking for high probability trading system, which would make money at 70% or more of cases. To find such a system, they are constantly looking for the correct inputs. If someone teaches such a high probability of input at the workshops, it attracts thousands of eager followers. However, at these meetings you rarely hear on the yields and the amount of positions as people believe that the secrets are hidden in inputs.
Unfortunately, if you look closely at these systems a high probability you will notice the following: (1) shows are successful because they are illustrated by numerous examples of the best cases, (2) the outputs of attention is usually not paid, except for statements that you should keep a trailing stop, and (3) if you test these systems, their expectation will not be the most good, because the average loss will be higher than average profits.
We are conservative in the profit and loss account in the risky
Good operating systems are often systems with reliability 40%, but which have an average income and a much bigger deal than the average loss. Understanding and appropriate use of protective stops and profit taking is extremely important for the development of such systems. However, these outputs are most difficult for the average trader who tries to take risks when late, and shows conservatism, when pulled forward.
Let's look at an example. What would you prefer: (a) likely to lose $ 900, or (b) 95% of losing $ 1,000 plus a five percent chance to avoid losses at all? Select (a) or (b).
Now let's try again. What would you choose: (a) a guaranteed income of $ 900 or (b) 95% chance of getting $ 1,000 plus a five percent chance to not get any money? Again, select either (a), or (b).
Most people in the first task selects risk. They prefer to lose 95% of $ 1,000 plus 5% of the output without loss. You have chosen? Let's see how this decision. If you multiply $ 1,000 by 0.95, you get the expectation of $ 950. This means that you have chosen the worst expectations, a loss of $ 950 just for the sake of a small opportunity to save money. Is not this tells the first part of the golden rule of trading? "Abort their losses." That you have chosen in the second problem? Most people choose a confident earnings of $ 900. However, if you look at paragraph (b), then it gives you an expectation of $ 950 ($ 1,000 x 0.95). But this runs counter to how most people think. They would rather choose the steady income than to risk when they are already ahead. As the rest of the golden rule of trading? "Let profits run."
Good trading system with a high expectation generated using the corresponding outputs. But when the proper use of the outputs goes against how we used to think it is very difficult to develop a good system.
People completely ignore the choice of the size of the position
Position sizing - that part of your trading approach, which tells you "how." It does not appeal. She did not give the appearance of your control over the market, as do the methods of entry. It just tells you what you risk in this transaction. You have already learned to play with balls that many people lose money in 60% of the system, just because of poor position sizing. And a large range of results in this game depends entirely on how much they are at risk. And all this can be your best assistant in the market. So why is the right choice of position sizing is such a problem?
Problem # 1: Error gambler
How can you lose money in 60% of the system at rates of one to one? In 60% of the system you probably have seven or eight losses in a row over 1000 attempts. But you could easily get such a system, and five losses in a row in 50 attempts.
For example, suppose you have adopted a strategy of betting on 10% of its capital. For simplicity, we add that this capital at the beginning of a losing streak is $ 1,000. You start with a rate of 10% or $ 100, and get the first loss. Now you have $ 900. You decide to bet $ 90 and get a second loss. In the remainder - $ 810. Now you decide to bet $ 81 and get the third loss in a row. Now you have $ 719. At this point, your thoughts might be: "I have three losses in a row and now the chances of winning are high. In the end, it's 60%-I system. I think it worth the risk at $ 300." Now you have four losses in a row and only $ 419 in balance. You feel despair. You have lost almost 60% in just four rounds. You think, "Now victory is inevitable," and decide to risk another $ 300. The number of losses increases to five, and the capital falls to $ 119. You will now have to earn around 900% just to cover the losses of the last five games, but your chances for a very, very slim.
Some of you may think that it was necessary to wait up to five losses in a row and then bet $ 300. If so, then you have the same problem. It's called the gambler's mistake. Your actual chances of losing in any given round is 40%. It does not depend on what happened in the past. When you make a mistake and gambler bet $ 300, you might as well get a sixth consecutive loss.
Problem # 2: The complexity of position sizing
Science position sizing - a problem as complex as the art of entering the market. Moreover, since few people are interested (or clearly understood) of the position, software developers ignore it or completely ignore the problem. As a result, if you want to practice the position sizing in today's world of computers, you have to do it yourself, in the table.
From their research, and other sources, I know how many "wizards of the market." They have a good system with a strong positive expectation. But these systems are not very different from those that can get the average trader. The difference between good fortune in the markets, which has made most of them, and the average income only in determining the size of the position. Great traders are subject to clear rules of position sizing to good systems and have the discipline to stick to them. Just read the Market Wizards - Market Wizards, Jack Schwager and. All of them in interviews talk about the importance of position sizing.
Many years ago I spoke at the conference Wizards Market in San Francisco. One of the speakers, Ed Seykota, focused on position sizing. When someone asked him, "How do you get to choose the size of the position?" in response, he pointed to his head and said: "I think."
Most traders find that the easiest solution for position sizing - simply trade one contract. This solution is for traders with small capital (ie, for most traders) means no position sizing, because they will at least double their capital before they can increase the risk.
Problem # 3: Most traders do not have enough capital
At the same conference, said Ed Seykota that risking more than three percent of the capital in a single trade jokes with fire. Your risk in this transaction - is the difference between your entry price and your stop level. For example, if you open a position in gold at $ 400 with a stop at $ 390, then $ 10 stop up the risk of $ 1,000. If you have an account with $ 25,000, then your risk for one contract - a four per cent. You would be called playing with fire.
Most traders come to market with accounts of $ 10,000 or less. They sell just about everything and all of their transactions are very risky, because the account size is too small. Of course, you can trade in some agricultural markets, with $ 10,000 in the account. In fact, you can trade in many other markets, if your feet are close, and your system is designed to close stops. But most people who come to the market, simply does not have enough capital to do what they're trying.
Therefore, they do not usually think about the most important factor in trading - how much to invest, because they trade too much. If they hold out in the market, as their account starts to grow, they begin to think about the simplest form of position sizing. "I now have $ 20,000 in the account. Maybe I have to go to trade two contracts."
Where is the solution?
I have presented various problems to illustrate why the average trader is so difficult to make money in the markets. This includes two main issues - (1) Development of high expectation and (2) position sizing. They are usually not considered as a psychological problem, but rather as problems approach. But both of these problems stem from psychological biases that shape our thinking.
The first step in overcoming these problems - the recognition that they exist. For example, once you agree that the key issue of successful trading - a system with a high expectation of winning instead of dominance, you come a long way to find a "Holy Grail". You can start looking for exits that give you a high expectation rather than inputs, which increases the number of correct guesses for your system.
Second, when you have a system with high expectations, which gives you a lot of trades, you start to realize that the key to achieving this expectation - position sizing. If you know what you want to accomplish as a trader (eg, a high ratio of risk-reward, low drawdown and high annual profits, etc.), you can use position sizing to develop an approach for achieving these goals.
My "Special Report on money management," details the three different models of capital and nine different models of position sizing that amount in the total of 27 different models. The report also addresses the creative approach to the selection of the size of the position, showing how this promising area. The path to the Holy Grail - an application of the position size in a system with high-expectancy and self-control. When you realize that deep inside, then make a giant leap forward in its evolution trader.
Van K. Tharp, Ph.D.
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