I am trying to figure out what is a safe money management scheme (ie. how much to risk per trade) based on the statistical probability of a certain number of consecutive losses (assume a risk:reward of 1).
I know that the percent of the account remaining after a number of consecutive losses (CL) will be:
Percent remaining = 100*[(1+risk)^(-CL)]
So, if one risked 1% on every trade and had 20 losses in a row, you would have 100*[(1+0.01)^(-20)] = 81.9% of your account remaining.
Now one has to figure out what the chance of a certain number of consecutive losses is and this is where I need help/input. Does anyone know how to calculate this?
I'm pretty sure my following logic is incorrect:
It makes sense to me that if we have a system that has a 50% win rate, then the chance of 5 consecutive losses is 0.5^5= 0.03125 = 3%
If my system has a 97% win rate, then the chance of 5 consecutive losses is 0.03^5 = 0.00002% (which is 1 in 41,152,263). The chance of 2 consecutive losses is 0.09% (or 1 in 1111).
By solving for Risk in the first equation above, it would appear that if I was comfortable losing 20% of my equity due to 2 consecutive losses (1 in a 1000 trades in my 97% win rate system), I could risk up to 11.8% per trade (which seems insane).
Risk = 10^[log(0.8)/-2] - 1 = 0.118 = 11.8%
Any criticisms? I'm sure something isn't right with this train of thought/math...
I know that the percent of the account remaining after a number of consecutive losses (CL) will be:
Percent remaining = 100*[(1+risk)^(-CL)]
So, if one risked 1% on every trade and had 20 losses in a row, you would have 100*[(1+0.01)^(-20)] = 81.9% of your account remaining.
Now one has to figure out what the chance of a certain number of consecutive losses is and this is where I need help/input. Does anyone know how to calculate this?
I'm pretty sure my following logic is incorrect:
It makes sense to me that if we have a system that has a 50% win rate, then the chance of 5 consecutive losses is 0.5^5= 0.03125 = 3%
If my system has a 97% win rate, then the chance of 5 consecutive losses is 0.03^5 = 0.00002% (which is 1 in 41,152,263). The chance of 2 consecutive losses is 0.09% (or 1 in 1111).
By solving for Risk in the first equation above, it would appear that if I was comfortable losing 20% of my equity due to 2 consecutive losses (1 in a 1000 trades in my 97% win rate system), I could risk up to 11.8% per trade (which seems insane).
Risk = 10^[log(0.8)/-2] - 1 = 0.118 = 11.8%
Any criticisms? I'm sure something isn't right with this train of thought/math...