Losses, not Profits, will Stop You from Trading in the Market

Should the market turn against you, it is important that you design a system that will produce as much loss as you are prepared to take. This loss, known as drawdown, is the maximum amount by which your trading float will temporarily drop at anytime. Doing this in advance, will help you avoid nasty surprises in the future. This gives you the confidence to continue trading when the good times start once more.

It is very unlikely that you will stop trading if your system is trading profitably. However, if you are in a trading year that takes too big a loss, you are likely to stop trading, even if your system has been tested and shown to make a profit over a longer time period. Therefore, design a system based on the risk you are prepared to take which includes a budget for your drawdown.

So how does one pick the best formula for your drawdown time? I will rephrase this question. How many losses in a row should you allow for?

First, I will use the simple example of tossing a coin. If I tossed a coin and it landed "Heads Up" 10 times in a row, are you surprised? However, if I tossed the coin 800 times, your outlook on the results are different.

Trading uses the same scenario. When testing your trading system over many years, you will find a run of 10 losers or 10 winners in a row. Mathematics provides some answers to the likelihood of this happening.

See the examples given in the table below:

----------------------------------------------- Probability of Losses in a Row ----------------------------------------------- System Win/Loss Ratio 60:40 50:50 40:60 ----------------------------------------------- 5 losses in a row 1% 3% 8% 6 losses in a row 0.4% 2% 5% 7 losses in a row 0.2% 1% 3% 8 losses in a row 0.1% 0.4% 2% 9 losses in a row 0.03% 0.2% 1% 10 losses in a row 0.01% 0.1% 0.6% -----------------------------------------------

A typical trend following a system has a 50:50 win: loss ratio. That is, half of the trades are winners and half losers. This is not a problem, because winning trades will make a larger profit than losing trades will make a loss.

A 50:50 system has a 1% chance of seeing seven losses in a row. Therefore, most trend following systems should budget between five and nine losses in a row. The good news is that there is the same chance of getting between five and nine winners in a row!

I hope you see the importance of making these decisions before you begin trading. Making the proper decisions before you start is what successful trading is all about.

-=-=-==-=-=-=-==-=-=-=-=-=-=-=-=-=-=-=-
David Jenyns is recognized as the leading expert when it
comes to designing profitable trading systems.

His most recent course Trading Secrets Revealed is a step-
by-step trading roadmap to having excellent money management.
Learn how *you* can become one of his students.
Click Here ==> http://www.trading-secrets-revealed.com

Re ceive David's free trading tips by sending a blank email
to: ==> trading-secrets-revealed.c om@getresponse.com
-=-=-==-=-=-=-==-=-=-=-=-=-=-=-=-=-=-=-

In The News:


pen paper and inkwell


cat break through


Two for the Money

Look back over the years and try to remember how... Read More

The I Word is Coming to a Town Near You

Hello Inflation, it has been awhile, I see you on... Read More

Starbucks Stock is Up

Starbucks earnings are up again and so is their stock... Read More

Shadow Bull

As one of my regular readers you know I have... Read More

Psychology ? How to Reduce Negative Thoughts Relating to Trading?

The thinking process of the brain relating to the... Read More

Buying New Issues

Has your broker been calling you recently with the "great... Read More

The Exclusive Club of Large Caps

Picture one of those clubs where only the real heavyweights... Read More

Your Trading Objective: Why is that so Important?

You've decided to try your luck at trading stocks or... Read More

The 10 Commandments

Wall Street has been preaching for years and years to... Read More

Stocks & Oil, Sat Jun 18th, 2005

Both the stock market and oil prices rallied recently, which... Read More

Mousetrap

The spring-loaded rat catcher is the ultimate low-tech device invented... Read More

Alfred E. Newman

What! Me worry?Many of you remember the cover of MAD... Read More

Why Technical Indicators

The fight continues to rage among traders who use technical... Read More

Trading Systems

To become a successful trader you must have some kind... Read More

Stock Market Education; Day Trading for Beginnners; How to Pick Stocks

The trading method you employ to approach the stock market... Read More

Moving Averages

Every day on CNBC-TV they show a 200-day moving average... Read More

Option Trading Basics

Options trading can increase the profits you make when trading... Read More

Hot Stock Investing ... How to Pick Hot Stocks with Momentum Stock Trading

Profitable day traders recognize that momentum trading is among the... Read More

Being Wrong Buying Stock is Okay

Being wrong is OK, but let's not carry it to... Read More

Making Outsized Returns in the Stock Market - Using the Dow Theory

The Dow TheoryCharles H. Dow... Read More

Trading Tips No 2: The Big Lie in the Stock Market

It is commonly reported that the stock market averages about... Read More

Shorting Stocks ? The Basics, Part I of II

What does it mean to short a stock?This means that... Read More

Hill of Hope

Just about now everyone is confused as to which way... Read More

I Love To Lose Money

Well, not really. What I mean is I don't mind... Read More

Enron Cure

Let's hope you did not have any of the Enron... Read More

High Price/Earnings Ratios and the Stock Market: a Personal Odyssey

After some forty years of banking and investments, I retired... Read More

Investing in the Stock Market

From the book 'The Stockopoly Plan' by the author Charles... Read More

Bottoms Ups

If you have talked to a stock broker or financial... Read More

A Penny for Your Stocks

According to Investopedia Inc. the penny stock market has seen... Read More

Discipline

One of the great "secrets" of successful people is discipline... Read More

Political Investing

We have two candidates for president that have really different... Read More

Rebalance And Diversify

The stock market has not been very kind to your... Read More

The Stock Market is a Roller Coaster: Prepare for the Ups and Downs

IT'S REMINISCENT OF THE OLD children's tale about an old... Read More