IP Lesson 3 Flashcards
BIG IDEA : Why is risk management the foundation of profitable trading?
Risk management is the first criteria of success because it is mathematically harder to recoup a loss, than it is to make a loss. Also the psychological impact of a loss tends to affect ( most people ) more strongly than a gain. for this reason, it is fundamental to absolutely minimize losses and risk through strict procedures, and through a healthy, neutral, and tranquil psychological approach. if risks and losses can be effectively minimized both in technical and psychological terms, profits will follow naturally.
Even potentially very profitable strategies can destroy a trading account unless there is this key factor.
Air tight risk management.
Example : A full loss of 1% on a 10k account is $100, but to recover that $100, how much profit is then required to recoup it?
1.01%
How do the number of pairs you trade affect levels of drawdown?
The more pairs traded, the more potential for drawdown. i.e. 20 pairs in 1% drawdown is 20% of the account.
If your account has entered a period of 20% drawdown ( 1% across 20 pairs ) what percent gain across half of those pairs would be enough to break even?
2%
What is the effect of multiple pairs in action when the market runs?
The move can be captured across many pairs at once.
Why is it essential to have reasonable expectations about the amount of time spent in drawdown relative to profit?
Because my account will typically spend more time in drawdown than profit.
Why is it ok if your account spends more time in drawdown than in profit?
Because the periods of profit will always gain more than the drawdown loses, even if they are shorter.
How can short periods of profit overcome longer periods of drawdown?
Because appropriately placed trailing stops mean that my account effectively limits drawdown, but let profits run.
Why is the most essential ingredient in trading success the ability to produce consistent profits, rather than starting capital?
Because producing consistent profits means that any capital available can be multiplied! Others will also be willing to invest ;)
What % or rule of thumb for risk management and strategy is an appropriate limit for drawdown?
15%
If drawdown approached 20%, what steps should be taken?
Either a change of strategy or reducing risk per trade.
What is the difference between you as a professional trader, and a gambler with respect to estimating risks and profits on a given trade.
I maintain a clear awareness of how much I can afford to risk on a given trade, while a gambler may focus more on what they stand to gain.
What is the basic attitude towards losses you maintain as a professional trader?
I cut losses short.
What is the basic attitude towards wins that you have as a professional trader?
I let profits run.
Why is rounding down when determining value an important step?
Because if I round up I could buy a pip value that is larger than a 1% risk.
Given that the ability to use leverage must be treated with great respect, and that the way to profit is through strict risk management and adherence to a statistical edge over time. And given that big wins come on their own, at unpredictable times, how do you view your role as a professional trader?
To simply create an environment in which such wins occur as often as possible, while keeping drawdown to the absolute minimum.
What is the difference between you as a professional trader and a gambler with respect to trading according to a system?
Gamblers try to win every trade, and attempt to read beyond strategies according to their own discretion. I simply trade my system.
Why does a discretionary approach actually limit profit, even if it can bank impressive gains on specific trades?
Because the discretionary trades disrupt the probability model, which is what actually generates profit.
Why, apart from the technical / financial risks, should trading be approached with tranquil, systematic calm, rather than emotion and discretion?
Because trading, when practiced emotionally is a negative sum game. Losses are felt more acutely than gains.
What is the effect of personal opinions and biases on trading?
Personal opinions and biases are a source of errors.
How is gambling defined?
Any activity involving change & risk in which the odds have not been calculated or are unfavourable.
In the example of an insurance company, the company may not know who will make a claim, so how is it that they can still make huge profits over time?
Because they can judge statistically what their costs and gains will be over time.
In the example of the insurance company, although they do not know who will make a claim and who will not, what is the effect of being able to make statistical judgements about costs and profits?
They make consistent profits despite the randomness in their business model.
You detect an opportunity that looks good, but is not a strict entry signal, how do you respond?
As a professional trader, I consider that gambling and wait for a strict entry signal instead.
You feel tempted to move your stop closer than your strategy permits, so that you don’t lose as much. How do you respond to this urge?
As a professional trader, I consider this gambling and therefore keep my stop in the position specified and documented in my strategy.
You feel tempted to not move your stop as close as your strategy states, in order to give price more room to move. How do you respond to this impulse?
As a professional trader, I consider that gambling. I place my stop exactly where my documented strategy states.
As a professional trader, what do your odds depend on? The movements of the market itself or….
As a professional trader, my odds depend upon the STRATEGY I trade.
If you feel tempted to risk more than your strategy permits, how will you respond to this impulse?
As a professional trader I consider that gambling and will risk only what my strategy states : 1%
If you feel tempted to risk less than your strategy states, how would you respond to that impulse?
As a professional trader, I consider that gambling. I risk exactly what my strategy states : 1%.
As a professional trader, at what times can you trade?
Only those specified by my strategy.
Which activities are considered gambling by professional traders as a general rule?
Anything that is published on a printed copy of their strategy.
Why is it so vital to learn how to identify the urges that are related to gambling behaviours, and how to self-regulate them?
Because gambling behaviours arise from natural human emotions and behaviours.
Why is it so vital to recognize that you MUST trade in accord with your strategy at all times?
Because trading my strategy strictly will at times feel wrong, because it is designed to capture movements that run contrary to natural human impulses.
BIG IDEA : Explain the difference between discretionary and systematic trading.
The distinction is fundamentally between trading based upon personal judgement, and trading based upon probability models. In practical terms, it is the difference between ANYTHING that is not a documented part of a strategy with a clear mathematical edge, and trading strictly according to a documented strategy with said edge, and which specifies entry, exit, position size, and other criteria.
BIG IDEA : Where does effective risk management begin?
With recognizing that common / default human psychology predisposes people to discretionary / emotional trading. This presents the opportunity to exploit the mass human psychology of the market by mastering one’s own psychology with regard to trading.
BIG IDEA : Explain why self-discipline, military grade accuracy, consistency, and self-management over time are the keys to success in trading.
Because it is adherence to the mathematical model of the system as closely as possible that produces the most stable, profitable, and safest results over time, but that the very act of following the system strictly is the key factor in the success of the system’s ability to produce results.
What is the basic mechanism for cutting losses short?
The stop loss order.
How does a stop loss order function?
By closing out the trade if the market moves against my position.
