Risk Relativity Ramblings

I thought this was another great example spot not only because I happened to “call” a few possible ops around it ahead of time in the room, but also because there is much to support recent discussions on the forum about the impact of risk/reward overlays on any strategy/process. As always, I advocate picking your spots well in advance and away from the current price action in the session as I did with this area as an educational example. “If the market goes here, I’ll look to do this, IF and when it gets there…” is always the type of rhetorical question you want to be asking yourself. Obviously this structure wasn’t put in play until late in the afternoon Wednesday, but here is what I said in chat many hours earlier that same day:

ROB@DTG:(10:11:57 AM):Gbx low 38s landed in no man’s land just spill from yd RTH low 42s. So I’d say YD CR into 42s one zone and perhaps 38s stand alone so to speak. Weak structure there so I’d be looking for maybe a crush into very key 28s-31s R to S below. Careful fading 38s unless post footfake crush for a scalp. Maybe good momo op playing with the crush beyond 38s or cont Pb after firm break below and PB to 38s-42s holding from under. Trading into 31s as a scale/flattening structure obviously.

As most members know this isn’t some kind of wizardry. I didn’t predict anything. Eventually the line in question was going to break and it just happened to be that same day. Furthermore though off this chart it did trade right down to the 28’s-31’s and if you take the time to go back and look you’ll see it got plenty of PA and flow action there to trigger your scale or flattening. Structures draw attention from both sides and always will. This is why we advocate using them to frame entries and exits as well as naturally expand and contract your risk overlay with volatility changes. But what you never know (as in this case) is that it was going to trade down to those 31’s in an exact rotational manner that will allow your risk overlay to profit from it ON THAT ONE TRADE!

Some things to think about…

What is your initial stop loss point on entry? Obviously if you sold the momo op in purple into the MM bid pulling, the market only moved that one way initially. You would have scaled at the bottom of the purple section at the earliest and no doubt would not have held out at the latest past the huge seller absorption in blue after all the stop flow behind the 38’s line was auctioned. Likewise if you were scalping the proposed post crush exhaustion bounce long from the blue area, you also would have taken no heat and been able to scale profitably into the pink or the red area at the latest. But what if you were stalking the continuation short op as a wider periodicity swinger? The PB back into the 38’s-42’s after firm break below as I suggested might materialize in chat. I think the second push on thin relative volume in red would have been a viable final entry trigger, but how big was your initial stop in this case? Guys who like to play tight risk and bigger rewards may have been stopped out long before the 31’s were reached. Conversely, those with wider inital risk say out past the 42’ YL line had plenty of room. Of course they had to risk 4 units or more to make only 6 units or so which is far less math advantage than those playing tight if they had also gotten away with it on the same trade. Perhaps risking only 1 or 2 units to make that same 6 units. No right or wrong here but you have to learn how YOUR R:R math unfolds over groups of events and decide what’s best for your approach. Also, what about any special situational trade management provisions? Do you have a reward side earlier exit rule for big relative volume spots when encountered early, like the action in green around the then current low? Do you scale some or all there when encountered? What do YOU do EXACTLY in those situations with your process? Obviously those without a scaling provision in this particular situation subsequently had to take some heat before the eventual march down to the 28-31’s structure. Do I think the action in dark red is remarkable in any way as a final trigger for the classic DTG’er style intraday swinger entry? No, I don’t to be frank. But I have highlighted it here mostly to show that guys trading short from the pink or light red would have at least taken heat there or been stopped out depending on what their scheme was. What would have been the outcome with YOUR risk overlay? All important questions to ponder…

The bottom line is the risk overlay WILL turn would be profits into losses and vice versa depending on what it is, and you can’t explain why trade by trade. When you would have lost anyway you’ll always wish you were stopped tighter, and when you would have caught the giant move if only your stop was looser…you get the idea. That’s why the risk model overall can only be evaluated in concert with all the other components of the strategy and only over larger GROUPS of trades, not one at a time as we harp on over and over in the community. The risk model will also need to be adapted over time as markets evolve as well. Lots of food for thought on how you want to handle these things. As always it will require lots of trial and error in SIM along with extensive ‘what if’ based manual backtesting (as we call it) in a variety of conditions to see how various criteria hold up over time. You just have to roll up your sleeves, mock up a range of various combinations with a given entry criteria and see what speaks to you. I can’t stress enough how critical it is to do this work and repeat it from time to time as markets evolve. It’s time consuming but hopefully you are passionate about finding answers and can have some fun shoving it all in the woodchipper and seeing what shakes out.

About the Author

Discovery Trading Group is a unique dojo focused on mentoring aspiring futures traders since 2010. It’s emphasis is on guidance in building bespoke processes and risk overlays rooted in market structure, price action and orderflow, with sound adaptable risk & bankroll management as a priority.

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