I am going to depart from planned content. I was going to comment on ‘Context and the Market Profile’. Instead I’ll continue with the current thread and write on managing the ES trade.

In The Expectancy of a Trade and Your Trading PIan I argued that the we had total control only over our entries and exits. In the Role of Intuition and Barros Swings - How to Use Them, we saw how the comment applied to the ES’s entry. I determine the size of my position both on the number of contracts I take and the amount of capital I am willing to risk. These are determined by a subjective assessment of the probability of exiting without loss. The risk I am willing to take ranged from 0.5% to 4%. In this case I was willing to risk 1% and take say, 6 contracts (the amount of contracts is for illustrative purposed only)

I found that because of the large stop (below 1535), 6 contracts would have cost me 2%. So I took only 3 at 1539.25. I wanted to add another 3 contracts on a breakout that conformed to my ideal breakout pattern. I treated this as a new pyramid trade. I could have added 6 and risked another 1% because I treat each entry as a separate trade. To prevent overtrading, I do have a maximum portfolio risk.

Although I could have added more than 6 contracts on the breakout - the breakout setup raised the probability of success and hence increased the risk and number of contracts - in this context I had decided to keep to 3. I had 1st resistance at 1496 and last night when the market stalled after reaching 1496, I had a dilemma. If I used the Rule of 3 and exited one third of my position size, I would not break even on the remaining open positions.

If I exited half my position size (the ones taken at 1469), then my risk per contract dropped to 10 points. So I exited half at 1488.5 and held half with stops below 1538.

Today with the CPI due, I decided to raise my stops on half my remaining positions to 1544 and keep the rest below 1538. I then had to work out if I should exit the remaining positions or let the stop take me out.

The inputs were:

a) I had no feel for the CPI figures so I rated the bear and bull response at 50%

b) If bearish, there was a 10% chance of no stops being hit, a 90% of the first stop at 1544 being hit and a 40% chance of the stops below 1538 being hit.

I then worked out the results in points for each secnario and placed the information in a Decision Tree Spreadsheet. Figure 1 shows the results. In this case, given the inputed data, the probabilities favoured letting the stops be hit.

Decision Tree

FIGURE 1 Decision Tree

As an aside, even if I moved all my stops to 1544 (90% of being hit), the matrix still favoured holding the position into the CPI. If I moved them all to below 1538, the matrix still favoured holding the position into the CPI. Based on this, I have reveresed my earlier decision and now my stops are below 1538.

TheMatrix worked out that only probabilities of 96% and above would favour exiting immediately. This would be true even I exited no higher than 1454. I have assessed that for that to happen we would need a headline rate of greater than 4% and a core rate greater than 2%. If the CPI numbers are that bearish, I’ll exit immediately.

The Decision Tree I use is sold by Palisade Tools. You can download a free copy of a Decision Tree matrix from www.visionarytools.com. If all you are after is a decision tree software, then use this. The only drawback with the permanent evaluation copy is you cannot save your work. To overcome this, all you need do is grab a snapshot before exiting.

So let’s stop back and suumarise this post:

a) We adjusted position size to allow for the larger than normal stop.

b) We took addtional positions based on new information,

c) We exited part positions when the market stalled at first resistance

d) We performed a Decision Tree analysis ahead of the CPI and

e) That Decision Tree analysis included a scenario where the CPI exceeded the upper boundaries of the expected range for tonight (bearish scenario).

By the way, the Decision Tree analysis did not stop there. I also did an analysis of what I would do if the lower boundaries (bullish scenario) are exceeded.

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