Money Management

[murray t turtle]

Quote from OddTrader:

Q

Money Management Traps
http://www.isigmasystems.com/mm2.html

Novice errors

Out of all the mistakes in money management, by far the most common is to take recklessly large positions. This typically occurs where a trader decides an instrument looks like a favorable profit opportunity and proceeds to accumulate the largest position his total equity will cover. Our money management article addresses this type of error in greater detail and provides a mathematical explanation for a wiser approach to issues of position sizing. Trading recklessly large positions, however, is not the only error traders make in money management.

Drawdowns: duration or severity?

There exists a common misconception that the way to control drawdown is to reduce position size in response to losing streaks. A popular version if this idea says to reduce position sizes by 20% for every 10% in losses. A more mathematically sophisticated (but equally wrongheaded) approach would be to modify the formula
Units to Buy = (Renormalization Coefficient * Equity) / Unit Price

to be proportionate to the ratio between current equity and historical maximum equity
Units to buy = (Equity / Max Equity) (Renorm Coeff * Equity) / Price

Effectively, this would mean that during sequential losses a trader would become more and more risk averse. During the series of losses, this might seem like the wisest idea, to trade the least when things aren't going well. Where this method fails in in real trading. When the losing period comes to an end, the trader is now constrained to trading a tiny fraction of the original position size so that the successful trades which recover from the losing streak are transacted at such a small size that it take the trader considerably longer to recover and begin generating profits again.

Raising the stakes

A less common, but more dangerous approach is to start trading bigger as losses mount. The assumption behind such a strategy is that drawdowns can be made shorter if winning trades, when they happen, are executed with large position size. Mathematically, this could be expressed as
Units to buy = (Max Equity / Equity) (Renorm Coeff * Equity) / Price

So for example, if equity should fall to 50% of it's historical high, the trader will now trade at twice the level of risk as before. Eventually, such practice will lead to a situation where a trader is taking positions large enough to entirely wipe out the trading account.

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Thanks for writing all that , including the latter way[paragraph] to ''to wipe out an account''

1] Find it helpful to reduce position size on swing/ position trading losing streaks;
because its opposite of your last paragraph.

2] Its tough on ones ego to reduce position size;
not near as fun/deadly as averaging down/losers.

3]Actually ''when the losing period comes to an end'' is when you go back to normal size, not constrained to ''such a small size''

4]If one does believe in trends, & this will not make sense to those who don't; why enter any size in a sloppy sideways trend.????
Sure option sellers /very short term traders could make money in sideways trends;
but this is referring to swing trading/position stocks.

 

[cnms2]

A couple of valuable conclusions from "Trading Strategies" by Larry Sanders (see page 16):

<img src=http://www.elitetrader.com/vb/attachment.php?s=&postid=934531>

These go against the common trend following strive for larger gains and higher average win / average loss ratio, at the expense of lower winning percentage.

 

[cnms2]

The easiest way to recall Kelly's formula (in my opinion):

Kelly_ratio = Expectancy / average_Win

Where: Expectancy = (average_Win * probability_of_Win) - (average_Loss * probability_of_Loss)

The most useful way to write Kelly's formula (in my opinion):

Kelly_ratio = probability_of_Win - (probability_of_Loss * average_Loss / average_Win)

It shows that the Kelly ratio can't be higher than the probability of Win. This means that, within certain limits, tweaking your trading system to get more wins at the expense of the (average Win / average Loss) ratio is more profitable at the same drawdown risk (hence capitalization). This is a mathematical explanation of why trend following systems register so large drawdowns for relatively limited profitability.

 

[cnms2]

The January issue of Options Trader magazine includes an interview with Max Ansbacher. I found it interesting that after many very successful years of selling naked options he eventually decided in 2002 to observe a stricter money management:
<img src=http://www.elitetrader.com/vb/attachment.php?s=&postid=945254>

 

[cnms2]

Avoid the Risk of Ruin - Fine-Tuning Your Money Management System by Bennett A. McDowell

This is a pretty good article that gives concrete guidelines on how to implement money management in your trading. It recommends a 2% risk sizing for a trading system that has a probability of win of 55% and and an average win average loss ratio of 1.6.

This means a Kelly ratio of 55% - 0.45% / 1.6 = 27%

So 2% is pretty conservative for this system (Kelly / 13.4). It gives a probability of 99% of maximum drawdown of 16.3% (account not to drop bellow 83.7%).

<img src=http://www.elitetrader.com/vb/attachment.php?s=&postid=946049>

 

[cnms2]

I just read a great post from Pete's Place journal. Actually most of that journal is worth reading.

The random entry crazy idea PetaDollar wrote about is Tom Basso's random entry system described by Van K. Tharp. In case you're interested to backtest it on equities yourself, there is an Wealth Lab script you can try. I didn't check the script, but I have no reason not to trust that author's work. My trials of that script didn't confirm Basso's results: it may be due to the fixed risk money management implemented, or may be due to the coarse grain of the back testing (daily OHLC data), or ...

 

[nononsense]

Quote from cnms2:

I just read a great post from Pete's Place journal. Actually most of that journal is worth reading.

The random entry crazy idea PetaDollar wrote about is Tom Basso's random entry system described by Van K. Tharp. In case you're interested to backtest it on equities yourself, there is an Wealth Lab script you can try. I didn't check the script, but I have no reason not to trust that author's work. My trials of that script didn't confirm Basso's results: it may be due to the fixed risk money management implemented, or may be due to the coarse grain of the back testing (daily OHLC data), or ...

Tons of posts have been done on this at ET's.
The same for MM or Trend gazing for that matter. Astrology works perhaps better. (I don't know. )
None of this can make money for you.
You need much better. Don't forget that you are playing against the nimblest minds money can buy.
Book stuff and websites known to everybody are interesting but simply will not cut.

nononsense

 

[ES335]

Quote from nononsense:

Tons of posts have been done on this at ET's.
The same for MM or Trend gazing for that matter. Astrology works perhaps better. (I don't know. )
None of this can make money for you.
You need much better. Don't forget that you are playing against the nimblest minds money can buy.
Book stuff and websites known to everybody are interesting but simply will not cut.

nononsense

Yeah, just use a "random non-linear chaotic strategy of the 3rd kind"against the nimblest minds. That's something nononsense cooked up, if anyone is wondering.

On a serious note, the above is wrong. The assertion that 'none of this' can make money is as wrong as it is vague and meaningless because it is backed by absolutely nothing but someone's opinion. And we all know, opinions are like assholes, everybody's got one.

 

[nononsense]

Quote from ES335:

Yeah, just use a "random non-linear chaotic strategy of the 3rd kind"against the nimblest minds. That's something nononsense cooked up, if anyone is wondering.

On a serious note, the above is wrong. The assertion that 'none of this' can make money is as wrong as it is vague and meaningless because it is backed by absolutely nothing but someone's opinion. And we all know, opinions are like assholes, everybody's got one.

Hey, what else are you bringing in besides opinion? Fact?
Better do some more research on nononsense's "random non-linear chaotic strategy of the 3rd kind" . You badly need it.

 

[ES335]

Quote from nononsense:

Hey, what else are you bringing in besides opinion? Fact?
Better do some more research on nononsense's "random non-linear chaotic strategy of the 3rd kind" . You badly need it.

I don't bring dogmatic statements to these threads, like I'm the pope of trading, the way you do. Therefore, I am never in a position where I have to bring facts to the discussion to support an absolute statement.

As you may have astutely noticed, I retracted my opinions in the divergence thread, which is something you will likely never be able to do. Re research: I have my own trading method, and I'm very pleased with it, so thanks but no thanks. Even if I did need to do research, the last place I would be looking for help in would be your posts sir, which are imho, absolutely worthless and which clutter this whole site like dog crap.

Now before asking others ask yourself, what have YOU brought to this site, after 3900 posts? Why don't we run a poll to see how useful people here think you are? I have less than 50 posts on this site and will likely never get up to 3000, and I have nothing to prove to anyone. You on the other hand, seem to stick your foot in every thread and come up with grand rulings from time to time, so I would think that some measure of your usefulness to people should help you put your posting in perspective.