Turtle Trading Rules

Chapter 15 Risk and Money Management (1)
Bankruptcy risk is the most vigilant risk.If you take it lightly, it could come at any moment and rob you like a burglar.

Like many concepts such as expected value, edge, risk of bankruptcy, etc., the term money management in the trading world also comes from gambling theory.You want to control the risk of bankruptcy to an acceptable level, but also want to maximize your profit potential. Money management is such an art.In order to do this, you need to determine the appropriate volume of the stock or futures contract, which is what we call the trade size, and limit the overall size of the position to control the risk of price volatility.Effective money management can help you ride out the unavoidable periods of adversity that are inevitable for every trader.Most discussions on this issue use countless mathematical formulas and various methods of accurately calculating trading volume, as if risk is a knowable and definable concept, but it is not.

I think money management is more of an art than a science, and perhaps more of a faith than an art.In money management there are no right answers, no best way to determine one's risk stance, only individual answers that work for the individual, and the only way to get those answers is to ask the right questions.

In essence, risk management is a balance between two extremes: on the one hand, the risk should not be too large, or you may lose everything in the end, or be forced to withdraw from the transaction; on the other hand, the risk should not be too small, Save little in return, and end up gaining nothing.There are two main situations where excessive risk forces you to give up trading: one is that the endless decline exceeds the limit of your psychological tolerance, and the other is that sudden price fluctuations eat up your account.

How much risk you should take depends on your individual circumstances.Therefore, if you want to trade, you must know what big risk and small risk mean to you.Only then can you make sound decisions.

Many people who sell trading systems and training courses just brag about it, as if anyone can make a quick and easy fortune using their methods.They do this to sell more systems and more training sessions.They will deliberately downplay the risks and overestimate the possibility and convenience of making money.

They are lying.Risks do exist, and trading is not a simple matter.

If you decide to take the risk, you must first keep in mind one important thing: a steady return of 20% to 30% per year can bring you huge wealth in a short period of time, no matter how much your initial investment is.The power of compound interest is incredibly powerful, but only if you don't go bankrupt and be forced to start all over again.If you invest $5 and you earn 30% a year, you'll have close to $20 million in 1000 years.

If you try to risk an average annual return of 100% or even 200%, your chances of failing flat greatly increase.I strongly recommend that newcomers to the world of trading take a conservative approach for the first few years.

Let's imagine the consequences of risky trading with the Donchian Trend System in 1987.Figure 8-1 reflects the trend that the magnitude of fading increases significantly with increasing risk level.

Clearly, the curve has been rising steadily until it turns horizontal after reaching the 100% level.This means that if you were risking 3% of your trading capital on each trade, you would have gone bankrupt overnight because the decline was entirely caused by a major reversal in the interest rate futures market that day of.

For most people, a prudent trading approach should limit the decline to an acceptable level, that is, according to historical simulation tests, the decline rate should not exceed 1/2 of your upper limit of tolerance.That way, even if your system suffers a large drop-off that you haven't seen before, you still have some buffer.Also, you're less likely to be swept away by an unexpected price shock.

Keep it simple, get to the core
Many people deify money management as the cure for all ailments in the trading world.Others have invented esoteric formulas and written books on money management.But money management shouldn't be this complicated.

Proper money management is actually very simple.For a trading account of a certain size, you can safely buy a certain number of contracts in each futures market.For some markets and some smaller accounts, this amount may be zero.

For example, the ATR of natural gas contracts (NYMEX) in early 2006 was over $7500 per contract.Remember, this means that the average daily fluctuation in the value of the contract is $7500.So for a system like the Donchian trend system that uses a 2ATR stop loss, it is possible to lose up to $1.5 on one trade.If your account only has $5, that means a 30% loss.Most people would say that betting 30% of your capital on the same deal is really not a good idea.Therefore, for a $5 account, the prudent volume of gas contracts should be zero.Even for a $100 million account, a loss of $1.5 represents a 1.5% risk of loss, which is considered by many to be quite a risk.

For beginners, risking too much is perhaps the most common cause of failure.Beginners are often so aggressive that a few consecutive losses can wipe them out.New traders often misunderstand the risks of leverage, so since their brokers and exchanges allow them to place large trades with as little as $2, they tend to actually take the plunge.

The concept of bankruptcy risk has already been mentioned earlier: a person loses too much in a string of failures and has to get out of the trade.Most of what people call bankruptcy risk refers to the risk of bankruptcy in a series of random outcomes, which are generated by highly simplified formulas based on probability theory.Most people think of it in terms of risk, thinking of bankruptcy as a string of losses in bad times.But I don't think that's usually why a trader goes bankrupt.It is not uncommon for traders to be overwhelmed by adverse shifts in randomness.More likely, they made serious mistakes themselves.

In my opinion, the following points are the main reasons for the failure of futures traders:

No Plan: Many traders act on intuition, hearsay, guesswork, and confidence in their own predictive abilities.

Risking too much: Many otherwise good traders go broke by taking too much risk.By big risk I mean more than 50% or 100% greater than the level of prudence.I have seen some traders risk 5-10 times more than I would consider prudent, even for aggressive trading strategies.

Unrealistic Expectations: Many new traders take excessive risks because they have unrealistic expectations about their profitability and level of return.This is why beginners believe that they can start trading with only those basic data.They believe they are smart enough to "beat" the market with that little information and little training.

When I started working on the futures trading system in high school, I noticed something very strange: Many of our customers were doctors, especially dentists.At that time, I thought that doctors liked futures trading because they had a high income and had capital to take risks in the futures market.Looking back now, I realize that was only part of the reason.I now believe that the real reason so many physicians are attracted to the futures world is their confidence in their intelligence and ability to translate success in one profession into success in another. Success - at this point, they may be overconfident.

A doctor is certainly very clever.To be a doctor, you need to get into a good university, pass various exams, and get excellent grades.And, once you graduate from medical school, you've achieved something that many dream of but few achieve.It was only natural for someone who was so smart and so successful in his early days to believe that he would be just as successful in the world of trading.

Many doctors wish they could become good traders in no time.The transaction looks very simple, they believe that it is not too difficult for them.But I find that a lot of people don't get it because they have unrealistic expectations - being successful in medicine doesn't mean you're going to excel in the trading world.

They don't understand that while trading is indeed simple (as I said earlier), trading is not easy.You can spend a lot of time and a long learning curve to realize how easy trading is, but most traders have to go through many failures to realize how difficult it is to do simple things and get to the core.

(End of this chapter)