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Three Trading Resolutions For The New Year
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Trade on longer time frames
As a retail trader you have two massive barriers which are the bane to your existence – spread and volatility. If you trade a short term time frame you are vulnerable to adverse movements in both.
Spreads at most brokers are variable and can go to 15 wide on daily basis even when nothing is happening. (Ever see EUR/JPY at 5PM NY Time?). If you are trading with 15 point stop there goes your trade. Volatility is similar. One big exporter order on the fix could flip your trade from a winner to a loser as prices scurry 20 points in 20 seconds and then come tumbling back.
Its all a matter of math. 2 point spread on a 10 point stop is 20% cost of business. Same spread on 100 point stop is 2% cost of business. The higher your costs, the better you have to be to make money and I am not that good – are you?
Focus on avoiding risk rather the chasing reward
Here is a simple exercise to consider. Take a strategy with 15 point target and 15 point risk. Now subdivide the equity into two halves. Trade one half on 15/15 basis and the second with 15 stop and 8 target. You have three scenario you lose on both halves you are -30. You lose on one half and make 1 take profit you are -7 (-15, +8) you will on both halves you are +23 (15+8). In the original scenario you are either -30 or +30.
So let’s compare and contrast. In worst case scenario you lose -30 both way. In best case scenario you win +23 on the 15 and 8 strategy and +30 on pure +15 strategy. So you are -7 on combo. However in the intermediate case you are only -7 on the combo but -30 on the pure +15 strategy. You are actually +21 on the combo. (You only lost 7 points on the combo and -30 on +15 – you would need to make up 21 points just to get equal to combo)
When you look at risk this way you realize that you have some very asymmetric payoffs. In the best case scenario the “bet it all on one target” strategy only gets you 7 more points, but the murky middle (where almost all of life and trading takes place) it loses 21 points. Effectively the combo strategy is a better because its a compromise between cutting risk and chasing reward.
(This is a very simple example to illustrate a point. Spare your emails on expectancy ratios, etc. I am well familiar with statistics. I also know stats often don’t mean jack in a non-static environment like the market)
Mix and Match
We all know that diversification is good because it creates non-correlated returns which are supposed to be less volatile. But here is something to consider. You don’t need two separate strategies to create a diversified portfolio. The same strategy using different stops and take profits can produce wildly different results that are not very correlated and can therefore provide the portfolio effect you seek. So when you mix and match don’t just look at different system look at same systems trading differently.