Stress-testing and «the Lucretius problem»
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Thread: Stress-testing and «the Lucretius problem»

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    Stress-testing and «the Lucretius problem»

    Hi there!

    Have you ever tried to calculate MIDD? Who is not familiar with this abbreviation – it is Maximum Intraday Drawdown. For now, this term is used not only for intraday drawdowns but for any drawdown.
    MIDD is used for calculating robustness of the trading system, its ability to come through different market conditions (that lead to losses) and recover from that – for example, if you trade within trading ranges and market appears to be trending and volatile, you might get losing streak. To calculate your lot properly, often it is recommended to calculate MIDD – historical drawdown.
    In applied statistics it is called "stress test" - you take the data, see the longest deviation from average and think that you've calcutaled the risk.

    But think about simple thing – drawdown that has occurred in the past, had exceeded worst expectations for that moment. The idea to take highest value of certain bunch of data and think that you know the historical extreme for all times comes to ancient poet Lucretius, that had said: «Fool thinks that there are no mountains higher than he had seen».

    You can argue that it’s the best of what we have.

    Well, world knows many cases of harmful applications of stress tests. Remember Fukusima – it was designed to survive certain earthquake (calculated from previous data). Remember «Long term capital management» - huge hedge fund has gone bankrupt using this principle. Also, other smart companies who have decided to apply this «risk management rule», gone bankrupt too – largest futures broker MF Global was speculating on Greek debt, until it gone bankrupt too.

    But you may ask me – ok, Stan, but how should one calculate working lot if not using MIDD?
    If I would suggest you to calculate your MIDD by 3 or 4, you would reject this idea, right? In this case your lot would be very small.

    But if you know that volatility can exceed all expectations, you can turn it around and use in your favor. For example – if you are position trader, you can split your position on 3-4 sizes and let profit run for 1/4 of it (or 1/3) without any limitations. There will occur some trends that will exceed everybody’s expectations and you will benefit from that.

    As for trading lot size, I use basically 1-3% of my account. Even in the worst case scenario, if I have 20-25 consecutive losses, I would not lose more than 25% of my trading capital. This drawdown is poor but manageable. If I reach 50% or 70% drawdown, it will be point of no return, nor financially not psychologically.

    That’s why I suggest to have financial reserve for worst case scenarios. But it’s useful not only for traders but for every entrepreneur too.

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    Last edited by Value trader; 12-03-2013 at 12:32 PM.

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    actually speaking i do not think that we need to get ourselves workout about all of this , if we are constant with the technical way of trading the Forex market like a professional then we should not be worried about the draw down as long as we have a better way to make money on a regular basis then i think we are good to go .

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    I have never heard this term before. I think this term is more of a technical than any other that professional traders use. To trade in forex, you first need to correct your basics than go for technical stuff. If you go the opposite way than your chances of loosing will be grater than chances of winning.

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    i see that you set money management with tight, just take 1 - 3 % as the risk, it will make us feel comfortable during trading forex, but sometimes there is something to push us to trade with take more risk, how can you control it ? and also if you see a good chances to make more profit, and sure with analysis, will you set your MM with take more risk to get more profit ?

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    Quote Originally Posted by newentry View Post
    i see that you set money management with tight, just take 1 - 3 % as the risk, it will make us feel comfortable during trading forex, but sometimes there is something to push us to trade with take more risk, how can you control it ? and also if you see a good chances to make more profit, and sure with analysis, will you set your MM with take more risk to get more profit ?
    well what i can say is that all forex traders need big capital because that 3% of margin is not too small, the only problem is that a trader who does not have big capital like $10000, may not be able to make big profit. But it is actually safer to trade with little margin.

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    Quote Originally Posted by newentry View Post
    i see that you set money management with tight, just take 1 - 3 % as the risk, it will make us feel comfortable during trading forex, but sometimes there is something to push us to trade with take more risk, how can you control it ? and also if you see a good chances to make more profit, and sure with analysis, will you set your MM with take more risk to get more profit ?
    I can add to my position, but only if it already generates profits - so, I can add risk only to my paper profit. But I do it very rarely. As for the question - how do I identify amount of risk associated with position (1% or 3%), it depends on type of the trade. For fast momentum trades, risk usually doesn't exceed 1.5% (15 - 20 pips), for swing trades stop loss must be a bit wider, I risk more on them than on momentum trades. Also, returns on swing trades are greater, but momentrum trades genereate sort of stable income flow.

    I would say, it works like a winery shop - to have cash to cover my costs, I sell beer (momentum trades), but to generate income, I should sell expensive cognac from time to time (swing trades)

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    Quote Originally Posted by jonking View Post
    well what i can say is that all forex traders need big capital because that 3% of margin is not too small, the only problem is that a trader who does not have big capital like $10000, may not be able to make big profit. But it is actually safer to trade with little margin.
    You can place just your loss limit on the market. For example, instead of depositing 10000 USD, you can have 3000 USD, and refer to it as your loss limit, thus your risks would be greater - you can risk up to 10% of this amount of money is a single position. But you should also be ready to support your margin if needed.

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    This is a very good idea, i have understood it now. It is talking about ways traders can perform their trades when things are not perfectly sure for him. The idea of splitting the trades will safe traders from many stresses of the market as they do not look for such numbers of trade, but the outcome of traders, you can trade some safely, and some aggressively.

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    Quote Originally Posted by silverlady View Post
    This is a very good idea, i have understood it now. It is talking about ways traders can perform their trades when things are not perfectly sure for him. The idea of splitting the trades will safe traders from many stresses of the market as they do not look for such numbers of trade, but the outcome of traders, you can trade some safely, and some aggressively.
    "Stress test" is a statistical term, it has nothing to do with emotional stress. It means that we explore how much stress your system can handle, not you as a trader

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    Actually the more your chance to profit more the more chance to lose in volatile market. We often face that recent momentum of market exceed all previous record.So i think there is no such thing dependency on stress test. We have to just calculate the outcome of an order. we have to take risk according to outcome. one time you may loss but don't lose your heart remembering that you earn more in previous in according to recent loss.

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