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How much to bet when you have an edge
- Thread starter jacksmith
- Start date
Quote from jacksmith:
We had come out a system. Backtest shows that the system can predict the direction of market movement correctly in 60% of time. (It is a system to predict if market will go up or down, but not how much). We believe that 60% correct predict ratio shall maintain in future.
Given these information,
1. What percentage of capital shall we bet each time ?
2. How to set stop-loss ?
3. How much leverage shall we use ?
Thanks.
1. Zero
2. Don't trade
3. Don't trade
Predicting direction 60% of the time is not an edge. You need to be able to also predict how much you will make when right, vs how much you lose when wrong. If your right calls are making 10% and your bad calls are losing 20%, then your strategy is a loser.
Back to research, get more data then once you've answered that question we can tell you how much to bet.
FWIW, if I have a strategy with a 60:40 win rate and a 1:1 payoff, I'd normally bet about 0.5% per trade.
Here's an interesting trade simulator. Useful for anyone with a system they "think" may be profitable.
http://www.hquotes.com/tradehard/simulator.html
Be sure to include accurate appraisals of slippage and commissions in any assessment of a trading system.
A figure such as 60% accuracy in predicting market direction is only a small part of the trading equation as the average loss to average profit are also huge factors... as well as the ultimate underlying factor... whether the system in question is robust enough to have a positive mathematical expectation going forward.
Back-testing is useful in proving you can make piles of money if you additionally have also invented a time machine recently.
If you have a robust enough methodology that you somehow absolutely KNOW has a positive mathematical expectation then you can use formulas such as fixed fractional, optimal f, %volatility etc.
Here is a good series of 3 articles on money management theories and its practical application to trading:
http://www.tsresearchgroup.ru/en/articles/public_20020402010830.php
And yet more info on money management principals:
http://www.forexproject.com/files/money_management.pdf
Also check out books by Ralph Vince, Van Tharp and Larry Williams... all have useful information.
More interesting discussions on money management techniques:
http://www.tradingblox.com/forum/viewforum.php?f=7
If I was pressed and had to give out some basic rule of thumb to a trader on what percentage to risk I'd stick to the good old 1-2% level with the caveat that you need to be able to a) have a system robust and that you are absolutely certain will have a positive expectation and b) that your guts and mind can withstand the inevitable drawdown and potential blowup when (a) is proven to be not so certain after all.
http://www.hquotes.com/tradehard/simulator.html
Be sure to include accurate appraisals of slippage and commissions in any assessment of a trading system.
A figure such as 60% accuracy in predicting market direction is only a small part of the trading equation as the average loss to average profit are also huge factors... as well as the ultimate underlying factor... whether the system in question is robust enough to have a positive mathematical expectation going forward.
Back-testing is useful in proving you can make piles of money if you additionally have also invented a time machine recently.
If you have a robust enough methodology that you somehow absolutely KNOW has a positive mathematical expectation then you can use formulas such as fixed fractional, optimal f, %volatility etc.
Here is a good series of 3 articles on money management theories and its practical application to trading:
http://www.tsresearchgroup.ru/en/articles/public_20020402010830.php
And yet more info on money management principals:
http://www.forexproject.com/files/money_management.pdf
Also check out books by Ralph Vince, Van Tharp and Larry Williams... all have useful information.
More interesting discussions on money management techniques:
http://www.tradingblox.com/forum/viewforum.php?f=7
If I was pressed and had to give out some basic rule of thumb to a trader on what percentage to risk I'd stick to the good old 1-2% level with the caveat that you need to be able to a) have a system robust and that you are absolutely certain will have a positive expectation and b) that your guts and mind can withstand the inevitable drawdown and potential blowup when (a) is proven to be not so certain after all.