Howard --
I take issue with your statement, "/Think about it this way -- You have
a profitable system. If you reduce your position size when trades have
some profit and, on average, the trades go on to be more profitable, you
forfeit some of the potential profit. If you reduce your position size
when trades have some profit and, on average, the trades go on to become
losers, your exit logic needs to be revised./".
Nobody HAS a profitable system. One may have traded or tested a system
that WAS profitable. But that does not mean the system IS profitable.
Therefore, the fact that profits were reduced in the past from a
historically profitable system, has very little meaning, as to what it
tells us about the future, if/when it bites the dust. If a system that
was profitable in the past becomes unprofitable when it is traded in the
future, scaling (and for that matter using stops) may protect one from
larger losses, or even complete financial calamity.
In order to test if a system might be helped by scaling or stops, one
should, I guess, test one that was unprofitable in the past. Of course,
nobody wants to test a loosing system!
The purpose of scaling and stops is to protect ones financial well being
from what we do not know. No matter how well we design anything,
including especially trading systems, there are always unknowns.
Please realize that I am not saying that scaling and/or stops are
advisable. I am just saying that it is very difficult to prove that
they are not useful.
Personally, I rarely use either scaling or stops. And when I do, it is
not because of any analysis. But only because it makes me feel safer.
-- Keith
On 7/30/2010 10:37, Howard B wrote:
Greetings --
Sohamdas wrote:
"Dr Bandy, what you said is true, about the second alternative. The
risk conditions are violated, with further scale-ins,when we double up
etc.
But consider, if with each scale-in, we also move the stop loss
point.In that scenario, the situation can morph into one, where the
risk doesnt increase linearly with position,it increases slower than
the growth of positions."
-------------------
I agree that the risk calculations change as the price moves in the
direction that gives profit. But in order to keep to the original
risk profile, the amount of the scale in is limited to the amount of
the gain. That is, before scaling in, recalculate the position size
permitted and scale in by that amount. The amount of additional
position size allowed is usually much less than the original position
was.
My argument against scaling in is with schemes that take a full
position at entry, then add an amount that is large relative to the
initial position (100%, 50%, 33%, or 25% are typical). Unless the
open profit supports the new position size of 200%, 150%, etc, the
risk is now higher than originally permitted. It is OK to do this if
you realize that by doing so you are using aggressive position sizing
and have worked through the consequences.
The original position could be taken at a position size that
anticipates all of the scale in trades will be taken. This assures
that risk will remain limited. But for those trades when the
conditions necessary to add a scale in position do not occur, only a
portion of the funds have been committed to the trade and the profit
is less than it would have been if a full position was taken at the
original signal.
I think it is better to treat each signal -- the original and each
scale in -- as a unique trading system. Work through the design,
testing, and validation of each separately, then apply position sizing
to each and to the portfolio that results from trading all of them.
Be aware that all of these systems will be trading the same data
series in the same direction, and an adverse price move will effect
them all the same, increasing the risk rather than diversifying it.
Think about it this way -- You have a profitable system with logic
that gives you good entry signals. If you wait until the trade shows
a profit to add to the position, you forfeit the profit from the funds
that were not used at the initial signal. If the scale in portion
gives better results than the original signal, then the entry logic
needs to be revised.
------------
The same situation occurs at scale out. A commonly described
technique is to take partial profits and reset the stop when some
condition is met. In almost all of the tests I have run using this
technique, the performance of the system over a period of many trades
is poorer than if the entire position is held until the final exit
signal.
Think about it this way -- You have a profitable system. If you
reduce your position size when trades have some profit and, on
average, the trades go on to be more profitable, you forfeit some of
the potential profit. If you reduce your position size when trades
have some profit and, on average, the trades go on to become losers,
your exit logic needs to be revised.
Thanks,
Howard
