The Nature Of Risk

What is the nature of risk?

The nature of risk is such that if you risk too much as a percentage of your portfolio in a given trade, that you can take any strategy, even those with a very winning expectation and over time LOSE money on what would otherwise be a winning strategy.

This is what most people do by

1)Trading too often
2)Trading while being underfunded
3)Trading with commission and
4)Trying to "time" how much to risk believing that somehow in the long run risking MORE than an optimal amount to "get abck to even" will somehow benefit them.

It is a mathematical certainty that over the course of your career if you attempt to adjust your bet size to risk more(when the odds remain the same) that you will be hindering the long term growth of capital over time. In theory people say "well if I start with a dollar and every tiem I lose that dollar I double down eventually I will get back to even. This is crap. Even Bill Gates would run out of cash after a losing streak that inevitably would happen. You are talking about a chance of losing an INFINITE amount of capital, so only to win HALF of $1 per bet. In no reality that I know of is that ever going to work other than to temporarily produce very very small gains before it wipes out EVERYTHING.

It is important after I talk about my strategy of "rebalancing" which means adding lower and reducing higher that a specify the complete difference because some people may be confused.
MAINTAINING a PERCENTAGE amount in a world with no fees over time may help but that is different than doubling down and increasing that percentage size of your portfolio towards that risk area.
So since we know that a FIXED percentage according to the odds is best (if the odds and edge improves that could allow slightly more risk to be correct if it goes higher or lower in theory, but in reality ignore this), how does our overall account growth rate per trade relate to the percentage at risk? Observe: What the heck is "fractional kelly" The kelly criterion shows you the optimal risk percentage in maximizing your portfolio/bankroll reward over the very long run.

As risk increases, volatility increases dramatically and exponentially. Perhaps not illustrated is the danger of overbetting as the return goes negative. In an environment where our reward to risk and our expected win rates are completely uncertain, overbetting risks jeopardizing our entire account balance over time. As such it is almost NEVER correct in stock trading to bet the exact kelly or even half of it, especially considering the nature of overconfidence, the tendency for past results to not equal the future, and that the relationship is such that you can STILL get 3/4ths of the return with half the risk. When you add in commission, ironically it actually favors risking less. At some point, if you have too much of limited capital you should not play because you are no longer profitable. However as long as you are still profitable, less is more favorable because the volatility creates an even greater problem of it being exponentially more difficult coming back and digging yourself out of the hole as the commissions are now an even GREATER percentage of your bankroll. This relationship is fundamental towards understanding why 90% of traders fail, and how to avoid being that 90% and focus on being the 10% that succeed. Once you understand how this relationship applys to ONE bet in a portfolio mixed with a percentage cash and a percentage towards that SINGLE bet, you can start to develop your understanding to account for multiple bets at a correlation between 1 and zero. We will cover that next.