How to evaluate efficient use of capital for each trade?

[Martinghoul]

Two wrongs. Let's see if we can make it right.
First, "return/risk//day" seeks what all of your economics classes tried to turn you towards: marginal return -- and even better, marginal risk-adjusted return -- and even better-better,

PV(marginal risk-adjusted return)

That is the understanding that each of us should have, for each and every trade, *before* we put it on, *and* after.

Capital efficiency -- like capital preservation -- is the shit.

And to put money AT RISK before you even know how that trade will affect your portfolio (on its own, and as compared to all *alternative* uses of your capital) -- is NOT what you want your money manager to do -- even if YOU are your money manager.

{stepping off soapbox now....}

Second big thought: To the OP: don't confuse position reward/risk, with portfolio reward/risk -- these terms are conflated all over the place, and they are starkly different. But you'll still hear people raving/comparing numbers that are completely and truly, apples to oranges.

If I pursue 50¢ on a $5 spread, I can claim a 10% reward-to-risk on that trade. But what will be my annual return on portfolio capital? We have no idea until we disclose how much total capital was available.

Algebraically, there are many different ways to get to the same result: time-weighted risk-adjusted marginal returns. End of story.

I am not really sure where I have said anything wrong...

Far be it from me to suggest that the basic measure I have suggested is the "right one". Ultimately, there is no right answer to these questions, since everyone has different constraints and different targets.

Broadly, this rabbit hole can be as deep or as shallow as you want to make it. Lots of clever people have lots of clever ways of doing this. As I said, you can do the basic thing, as long as you're aware of all the caveats, limitations and flaws.

 

[tommcginnis]

Staring at my trade screen and making educated guesses seems like a weak strategy. But I also am not looking to get lost in strategic theory and calculus.

Well, there's always signing up to be a greeter at Walmart.




[SHEESH Tom! Heavy on the *snark* today!! ]

 

[Martinghoul]

tommcginnis,

Just saw your post. You said it better than I. My previous post suggests analyzing capital efficiency probably can't be done without consideration of capital preservation (risk).

Staring at my trade screen and making educated guesses seems like a weak strategy. But I also am not looking to get lost in strategic theory and calculus.

Here's a simple question for you that may influence the choice of methodology...

Do you care about the mark-to-mkt PNL of your trades or do you only care about the "terminal" PNL at expiry?

 

[Libranalysis]

I hope I care about both .

But when choosing a trade terminal PnL (max profit?) is more important right? That's a static, concrete value. Managing trades involves analyzing mark-to-mkt PNL. (?)

 

[Martinghoul]

I hope I care about both .

But when choosing a trade terminal PnL (max profit?) is more important right? That's a static, concrete value. Managing trades involves analyzing mark-to-mkt PNL. (?)

Well, only you yourself can answer the question of what's more important...

Point is that the choice you make in answering this question determines your interpretation of the term "risk". A measure of risk that you choose can go into the calculation which you perform to evaluate trades (although there is some overlap since margin is your broker's estimate of a given trade's risk, among other things). For a standalone trade, your goal, I imagine, should be to find the trade with a highest expected return that has the least risk, however you define it, requires the least margin and has the shortest time to realisation. For a portfolio, this optimisation gets a little more complicated.

 

[ironchef]

Kelly?

 

[teachamantofish]

to find the trade with a highest expected return that has the least risk, however you define it, requires the least margin and has the shortest time to realisation. For a portfolio, this optimisation gets a little more complicated.

I think I hear an echo in the room.

BTW, Walmart turned down my application so I decided to become a trader instead. The blue vest clashed with my red suspenders anyway.

 

[teachamantofish]

Let me phrase it a different way: My decisions tend to be situationally ad-hoc. That is, based on news, market trend, price, forum posts, how many cups of coffee I've had, etc. I'm trying to devise some objective way to compare trades with one another. The "way" might be subjective, but the future analysis would be entirely objective and based on specific criteria.

 

[DeltaRisk]

Do you mean "Portfolio margining" or "managing"?

Yes, I already learned "profitability is difficult" the hard way. But my question speaks to increasing profitability--I'm looking to both increase the number of trades I can do as well as the premium I collect by improving the way I leverage margin/buying power. Of course, picking the right trade within a set of possibilities is certainly difficult.

One problem with my rudimentary formula is the absence of an accounting for probability of profit/risk. In the example below, the premium on the 10 strike is 4-6 times higher than the 9 strike but the effect on my buying power is only a 10% difference between the two. My forumla says going short the strike 10 is a 6x better use of my buying power, but selling the OTM 9 strike is certainly a trade that's more likely to win.

View attachment 175588

I suspect I'm reinventing the wheel and may have to circle back to the brain numbing reading topics you suggested.

Actually to save time, you can use the search here. Some here are very smart and the comments might help you with actual execution and working knowledge.

Yes, I do mean portfolio margin.

It's incredibly difficult to find something that works all of the time, most traders here only have a probabilities based approach to trading. Not saying that's bad, it just never was what I was after.

I don't believe anyone gives away things that work in trading for free. You'll need to watch and study study study and probably stay clear away from anyone selling get rich quick trading education. I.e. Tim Sykes

 

[Libranalysis]

The posts on this board tend to be of a higher caliber than I've seen elsewhere. Thanks to all who participate.

I do hope to kick my trading up a notch. I created a number of JavaScript-powered Google charts that allow me to review my performance by week, duration, strategy (i.e. short put vs straddle or whatever), etc. That's been a big help and a real eye opener.