Money Management

Quote from cnms2:

Thanks. I actually have Ryan Jones's book "The Trading Game: Playing by the Numbers to Make Millions", but I haven't even browsed it. What did you find to be most useful in this book? I read Amazon.com's reader reviews, and it seams that RJ proposes the "Fixed Ratio" money management system that is useful for small accounts too.
More...

It appears to me most if not all trading books I read so far would be probably produced mainly for promoting certain trading related services by the writers of the books.

I wouldn't expect the writers to disclose (m)any of the secrets they learned/ discovered from their (painful? :-) experiences, imo.
 
Is there ever an optimal position sizing ( money management ) rule? ONLY if you know for sure what is the absolute worst black swan loss in the future, which we will never know. So, if you have a postive expectancy system according to your research, the best money management strategy trades a position size that generates the greatest return for you and tries to ensure you are not taken out by any future black swans. You can increase return by increasing leverage or position size, but it increases your risk of ruin.(risk of taken out of business) Hence, to me, position size or m.m. is a personal preference and also depends on what stage you are in as a trader. If you are still young, you can afford to take on more risk and vice versa. There is no absolute answer.
 
This is an excerpt about options trading money management from another forum. Michael is an experienced options trader that is always ready to give an insightful advice. He's great at explaining clearly even the most complex things.
"... cut your losses and move on. the first rule of money management
should be to limit your losses. by selling out now, you will have
hopefully experienced only minimal losses and maintained proper trade
discipline.

at what point should you exit? there are many schools of thought but i
am most comfortable with establishing position risk and loss limits
using a modified kelly system. basically the kelly method is adapted
from gambling theory and is a way to quantify your "bet size" (in this
case position loss risk) based on your capital and expectancy, the goal
is to optimize your position size while limiting your risk of ruin.

the kelly formula is %winners *(average$per win/average$ per loss
-1)/(avg$per win/avg$ per loss) so that for example if you win on 40% of
trades and have an average win/loss ratio of 1.5 to 1, the kelly =
.4*(1.5-1)/1.5 = .133. i use a "20% kelly" which means in this example
that i would risk no more than 20% of 13% of my capital or 2.66% of my
capital.

i use the kelly along with option greeks to set stop loss and position
size thresholds before entering a trade. thus, following the above
example, assume i have initial capital of $20000. my 20% kelly says that
i should risk no more than 2.66% of that or roughly $530. i look at
an option that i want to buy. as a buyer i know my main greek risks are
theta (time decay) and vega (volatility decline). for the particular
option i am interested in lets assume that the theta is $2 and the vega
is $25. since vega looks like the bigger risk i ask "what if IV drops
20% from its current level of 16%?" that would mean IV would be then
12.8% (.16 *(1-.2) = .128). that would put me at a vega risk of about
$80 per contract: (16-12.8)*$25=3.2*$25=$80. with my kelly telling me to
risk no more than $530, i know i should have no more than 6 contracts
(530/80 =6.6 or 6 rounded down). then i look at theta. at $2 per day
and six contracts, i can calculate how long to stay in the position:
$530/($2*6)=44 days. so now i have my exit parameters. if IV drops
below 12.8% i'm out. if the position shows no gain, i am out in 44
days. obviously if price movement reduces the value of the position by
$530 at anytime, i'm out.

so basically i'm suggesting that the best way to limit losses is not by
trying to find a killer adjustment strategy to a losing position.
rather, the idea is to have an exit plan in place with set thresholds
and reasons for closing. obviously some adjustments can be made but
often the most prudent thing to do is just get out."
More...
 
In most cases it is probably good enough to rely on a general consensus for position sizing: i.e. the total risk of your open positions to be about 5-6% of your account (risk being the amount you lose if all your stop losses are hit). You should also make sure that you know your maximum risk and are comfortable with it. If not, back down your sizes until you feel comfortable.

If you take time to analyze your trading history to calculate your percentage wins/losses, your average win and your average loss you can better optimize your sizing for better profits. On the other hand there is always the danger that your historical data is too small and it hasn't yet encounter adverse streaks, so you might draw too optimistic conclusions about your trading performance and get too aggressive.
Quote from OddTrader:
Absolutely, very much "system/ personality" dependent, I would think.
More...
 
Quote from cnms2:

In most cases it is probably good enough to rely on a general consensus for position sizing: i.e. the total risk of your open positions to be about 5-6% of your account (risk being the amount you lose if all your stop losses are hit). You should also make sure that you know your maximum risk and are comfortable with it. If not, back down your sizes until you feel comfortable.

If you take time to analyze your trading history to calculate your percentage wins/losses, your average win and your average loss you can better optimize your sizing for better profits. On the other hand there is always the danger that your historical data is too small and it hasn't yet encounter adverse streaks, so you might draw too optimistic conclusions about your trading performance and get too aggressive.
More...

Perhaps one of the key elements in deciding optimal bet size, imo, would be the (dynamic?) correlations among the assets (providing keeping/ trading the same assets with same weighting all the times).

I guess the correlations based on historical data might be sometimes not good enough to measure/ define/ predict the "you know your maximum risk" in the future trading environment, using whatever available tools/ calculations such as Kelly, Terminal Wealth Relative, VaR, double summation, etc.

Using "Average" for problems such as MaxDD/ MaxConsecutiveLoss/ etc. and how to define them could be another interesting issue for me to learn. Just my 2 cents.
 
Quote from OddTrader:

That's quite interesting. Thanks.

http://www.iitm.com/products/product_list.htm
More...

Q

As already mentioned, the major flaw of the Kelly formula is it assumes two outcomes only - a winner of a certain magnitute and a loser ... For a better approximation of the optimal trade size, one should determine what is popularly known as the optimal f, which requires a slightly more complex calculation.

--- Chapter 24 The Kelly Formula, Trading Systems and Money Management (Thomas Stridsman)

UQ
 
Here there is a probability analysis that justifies using 1/4 to 1/6 Kelly for sizing your positions (risk). The table shows the probability of "never being unhappy" as the author names it, for different combinations of maximum drawdown (a) and Kelly fractional (x=1/k of Kelly):

  • "We look more closely at some special cases of the formula to see how Kelly fractions affect risk. In the sequel, we introduce the variable x=1/k, the inverse of the Kelly fraction. Thus x=1 and x=2 correspond to full Kelly and half-Kelly, respectively.

    In the table below we tabulate the function f(x)=1-a**(2x-1), which is the risk that you never reach the value a, as a varies from .5 to .8. For a=.5 it appears that this risk of being halved gets very small and doesn’t change much as x increases above 4. This indicates (quite subjectively of course) that there is little reason for blackjack players to be more conservative than quarter-Kelly. Some futures traders suggest k=1/6, a conservative fraction perhaps due to the fact that traders are not usually sure of their edge (among other infelicities).

    The risk of never being unhappy
    (the probability of never reaching a=.5 to .8 for x=1/k=1 to 6):
    Code: 
          x:    1       2       3       4       5       6

a

0.5     0.500   0.875   0.969   0.992   0.998   1.000

0.6     0.400   0.784   0.922   0.972   0.990   0.996

0.7     0.300   0.657   0.832   0.918   0.960   0.980

0.8     0.200   0.488   0.672   0.790   0.866   0.914
    "
You may find the whole document here.
Quote from OddTrader:
Q
As already mentioned, the major flaw of the Kelly formula is it assumes two outcomes only - a winner of a certain magnitude and a loser ... For a better approximation of the optimal trade size, one should determine what is popularly known as the optimal f, which requires a slightly more complex calculation.

--- Chapter 24 The Kelly Formula, Trading Systems and Money Management (Thomas Stridsman)
UQ
More...
 
You must log in or register to reply here.
Back
Top