Timeframe & Trade Frequency

An important factor to keep in mind when determining your per trade risk and defining other factors in your money management scheme is trade frequency. That is tied in with your timeframe.

Generally speaking, those with shorter trading timeframes will make more trades over a given span. Someone doing daily market analysis, after all, is going to identify more trading opportunities than one only doing weekly analysis.

The question then can be framed in terms of time. How large a loss would you be fine taking over a given timeframe? For the sake of this discussion, we will use a year, but you can certainly pick a timeframe more to your liking.

For the sake of argument, we will say that we can tolerate a 25% drop in portfolio value over the course of a year. With that in mind, we can look at things from the perspective of three different trade frequencies – daily, weekly, and monthly.

We will say that the day trader makes about 200 trades per year (accounting for time off and days when no trades are done). The weekly trader does about 50 trades a year, and the monthly trader puts on a dozen trades.

Take a look at the table which follows. It outlines how frequently consecutive losing trades can be expected to happen given the number of trades done for each timeframe. The figures are based on an assumption of a 50% win rate.

	Day	Week	Month
Trades/Yr	200	50	12

% Odds of a Run of Losses
3 Loss	100%	99%	55%
5 Loss	96%	46%	13%
7 Loss	61%	16%	3%
10 Loss	1%	0%	0%

The information in the table above is handy in that it can be put to direct use as we decide on our per trade risk. We know that for the day trader it is almost assured that there will be at least one run of 5 straight losing trades each year, and quite likely that there will be at least one run of seven straight losses.

This means that if we are trading that frequently, and do not want to get down more than 25% on our portfolio, we want to risk less than about 3.5% per trade (25% divided by 7 trades). In fact, if we put our risk at the 2.5% level, we are almost assured that we will not hit our 25% drawdown point (10 x 2.5%).

Using that same thinking, the implication is that we could take on more risk on a per trade basis. For example, we might be willing to accept a 16% chance of a 25% drawdown for weekly trading, so could base our per trade risk on a run of seven trades. That means about 3.5% risk per trade.

Similarly, at the monthly level, a 13% chance of a 5 loss run could be considered reasonable. We would then be willing to put 5% of our portfolio at risk for each trade.

Again, these figures are based on a 50% win rate, so basically a coin toss as to whether a trade is a winner or loser. Also note that the probabilities shown above are for at least one run of that length. There could be more than one. Also, you have to take in to consideration the fact that there could be two runs of losses sandwiching only one or two winning trades.

The actual risk of hitting our 25% risk point, therefore, is a bit higher than what the numbers in the above table suggest. That is in terms of chance, anyway. Keep in mind that we have not added the ratio of average winning trade to average losing trade in to the discussion. That can completely alter things.

The real RoR, if we consider 25% our Ruin point, goes way beyond just win rate. It takes in to account all the factors of exposure and return to come up with a probability. To test things out for yourself, go to http://www.andurilonline.com/book/calculator.aspx and play with the risk tool there.

Risk Management Tool Output