Money Management
- Thread starter cnms2
- Start date
I agree even if a small risk is taken per trade risk is meaningless without limiting the # of trades.
http://www.elitetrader.com/vb/showthread.php?s=&postid=902372#post902372
Dr. Alexander Elder writes in his "Come Into My Trading Room":
- Whenever the value of your account dips 6% below its closing value at the end of last month, stop trading for the rest of this month. Calculate your equity each day, including cash, cash equivalents, and current market value of all open positions in your account. Stop trading as soon as your equity dips 6% below where it stood on the last day of the previous month. Close all positions that may still be open and spend the rest of that month on the sidelines. Continue to monitor the markets, keep track of your favorite stocks and indicators, and paper trade if you wish. Review your trading system. Was this losing streak just a fluke or did it expose a flaw in your system?
Quote from OddTrader:
Don't we usually define a MaxDailyLossLimit before starting a day?
es335,
the 1% (or 2%) is a simple form of diversification of the 5% (or 6%) risk. The 5% is a rule of thumb, but if you have a well defined system that you traded long enough to have some statistical data the best way is to do your own calculation.
With your win/loss ratio and average win / average loss ratio you calculate your Kelly ratio. This tells you what is the percentage of your trading account that you should bet to have it grow at its maximum possible rate. Using this number may cause you large drawdowns that you may not be willing to go through. For this reason (as demonstrated in one paper I referenced before), you can use a 1/5 or 1/6 of your Kelly ratio, with more than 90% chance of not having a drawdown larger than 20%, and about 100% chance of not getting halved.
If your Kelly is 30%, then 1/5 or 1/6 of it will give you the 6% or 5% recommended by many authors without any demonstration.
Obviously betting less than the optimal Kelly percentage will reduce the slope of your equity curve, but you'll feel safer. On the other hand if you trust yourself and your trading system, you can take more risk and in the long run you should see better returns.
I agree with your suggestion to see the risk diversification not only vertically on the positions that you have opened at the same time, but also horizontally as positions opened successively.
the 1% (or 2%) is a simple form of diversification of the 5% (or 6%) risk. The 5% is a rule of thumb, but if you have a well defined system that you traded long enough to have some statistical data the best way is to do your own calculation.
With your win/loss ratio and average win / average loss ratio you calculate your Kelly ratio. This tells you what is the percentage of your trading account that you should bet to have it grow at its maximum possible rate. Using this number may cause you large drawdowns that you may not be willing to go through. For this reason (as demonstrated in one paper I referenced before), you can use a 1/5 or 1/6 of your Kelly ratio, with more than 90% chance of not having a drawdown larger than 20%, and about 100% chance of not getting halved.
If your Kelly is 30%, then 1/5 or 1/6 of it will give you the 6% or 5% recommended by many authors without any demonstration.
Obviously betting less than the optimal Kelly percentage will reduce the slope of your equity curve, but you'll feel safer. On the other hand if you trust yourself and your trading system, you can take more risk and in the long run you should see better returns.
I agree with your suggestion to see the risk diversification not only vertically on the positions that you have opened at the same time, but also horizontally as positions opened successively.
Never read this book yet:
Trading Risk: Enhanced Profitability through Risk Control (Hardcover)
by Kenneth L. Grant
http://www.amazon.com/gp/product/04...102-1237962-6951363?s=books&v=glance&n=283155
Trading Risk: Enhanced Profitability through Risk Control (Hardcover)
by Kenneth L. Grant
http://www.amazon.com/gp/product/04...102-1237962-6951363?s=books&v=glance&n=283155
A practical example, please? Thanks.
A practical example, please? Thanks.
On another thread macy posted:
You can further reduce your risk exposure through diversification, and this can be done by opening i.e. 5 positions in 5 different assets, risking on each only 2.5%.
If you're an active trader it may be more difficult to track several positions at the same time, so you may consider horizontal (sequential) diversification. You have to decide on what time frame are you willing to risk the 12.5%. If this is one week, and you make about 10 trades / week, you should risk 1.25% per position.
If you had a a bad streak and your account is down 12.5% you should take a break, should review how it happen, and restart trading only after you cooled down.
Using a fractional Kelly reduces your risk, but at the same time it substantially slows your equity curve slope too.
After only 8 trades (2 losses, 6 wins):
Compounding is truly amazing!
- "...I am 70-80 percent accurate in my trades, and my losses are limited to about 1%. ... my winnings are usually 2 percent...."
You can further reduce your risk exposure through diversification, and this can be done by opening i.e. 5 positions in 5 different assets, risking on each only 2.5%.
If you're an active trader it may be more difficult to track several positions at the same time, so you may consider horizontal (sequential) diversification. You have to decide on what time frame are you willing to risk the 12.5%. If this is one week, and you make about 10 trades / week, you should risk 1.25% per position.
If you had a a bad streak and your account is down 12.5% you should take a break, should review how it happen, and restart trading only after you cooled down.
Using a fractional Kelly reduces your risk, but at the same time it substantially slows your equity curve slope too.
After only 8 trades (2 losses, 6 wins):
Code:
Risk Drawdown Profit
-----------------------------
1% 2% 10%
12.5% 24% 190%
62.5% 86% 1700%