reward/risk = 10:1 , win/loss = 1/10

K

koms

Dear Friends,

Scenario:

Markets under consideration: S&P /Nasdaq/Dow.
Lets assume that today is 10/21/2005 ( Oct 21st, 2005 ) , now looking through a novice eyes the market conditions look like 90% markets will go more down and only 10% markets will go up.
so for a Buy trade win/loss ratio is 1/10.

Now, say I/you have some home grown reversal strategy which tells me/you that markets will most likely reverse to upside and continue going up till dec 01, 2005 ( 12/01/2005).

Here comes the question:
Lets say I/you have only $1000 to risk ( and do not mind losing the entire amount), but if the market goes up the way it actually did ( see charts from oct21 to dec01 , 2005 ) then I/you would like the returns to be 10 * 1000 = $10,000.

assumptions:
Markets may dip a little bit down before they turn upside ( should not be stopped out )

So now if you are in my situation how will you trade to achieve the goal ? please explain in details.
e.g. options/futures/spreads/SPY/.... ?

If this goal is impossible than whats the max you can achieve.
 

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I understand that in order to be profitable you need a good system. But even if I had a good system I am trying to understand that with given limitations ( Acctsize = 20 K , max risk on one single trade = 1 K ) how could I maximized the profits .
What kind of trading instrument is best suited for this startegy with given limitations and what is the max profit it could have achieved ?
 
One way to think about the question "What investment returns can I expect to make?" is to obtain data on the returns made by top money managers, hedge funds, CTAs, and so forth. These guys and gals charge fees, pretty steep ones, but still deliver wonderful returns to you the investor, even after deducting fees.

You can learn their names by reading the Market Wizards books and then googling them. Or you can go visit websites that track and rank hedge funds & CTA's. Then you can download their track record (which shows the returns after deducting fees).

This data will help you see just how well (or how poorly) the pros perform. If you think you are just as good as the pros then you can take their returns, add back the fees since you won't be charging yourself a fee to manage your own money :p , and presto you've got an estimate of how well you'd do.

Some of them trade instruments like futures and forwards which allow lots of leverage. You can do "what if" scenarios: what if you traded just as the pro trades, except you use more leverage? Answer: your returns would be higher and your risk would be higher. Maybe this is okay for you. The pros are serving some pretty risk-averse clients (pension funds etc.) so maybe it's ok for them to earn 25% returns with 5% drawdowns. But maybe you can tolerate 40% drawdowns! Then you can use a lot more leverage than the professional money manager, and willingly accept more risk in exchange for more reward.

However you may decide that it's difficult to beat, or to equal, the performance of the pros. Then you can either (A) give them your money and let them do the trading; (B) adjust your expectations downwards and realize that your results will be worse than the pros' results.
 
Quote from koms:

Here comes the question:
Lets say I/you have only $1000 to risk ( and do not mind losing the entire amount), but if the market goes up the way it actually did ( see charts from oct21 to dec01 , 2005 ) then I/you would like the returns to be 10 * 1000 = $10,000.

assumptions:
Markets may dip a little bit down before they turn upside ( should not be stopped out )

So now if you are in my situation how will you trade to achieve the goal ? please explain in details.
e.g. options/futures/spreads/SPY/.... ?
More...
For this situation I would recommend going long options or futures.

For futures you need to define the maximum that the markets "may dip a little bit" because that determines how much you can leverage you can use (without losing so much that you are stopped out during the dip). I'm assuming that you have more than $1000 to work with and are simply limiting your risk to $1000, which isnt the same as saying you only have a $1000 account (because of margin requirements)

For options the only thing you really need to worry about is the timeframe; In your hypothetical you have nailed down to a specific date. If in late Oct you want to target Dec 1st then you need to pick an option with an appropriate expiration date (e.g. after your target date). Of course knowing how big the move up will be would certainly make it easier to pick the options with the best leverage (buying further out of the money options would be cheaper, e.g. you could get more of them for $1000 but if it fails to reach that target you end up with nothing).

So with futures you can't be tolerant of a drawdown since once are down $1000 you have to liquidate and call it quits, however you aren't locked into a specific timeframe. With options there is no drawdown risk (assuming you spend no more than $1000 on the options themselves) but you had better be right about the timeframe. Pick your poison.
 
Thanks to everybody for guidance.

2 more questions:
1) Which option ( Dow/S&P/Nasdaq/DIA/SPY/QQQQ/... ) could have proved more profitable, since every instrument has different price value e.g. YM is in 10K price and Es is in 1.2K price, therefore % rise will be different. Does this matter ?

2) Can some guide to to a correct reading material where I can learn more about Out of the Money call/put options.
e.g. if the underline market increases will the options price increase 1:1. what if the markets go 80% in my favor but still I am Out of the money by 20% where will my profit loss stand in this case , can I get out at this point if I get a gut feel that market will not hit my target ..

3) How do I backtest using option entries. Its simple with futures/stocks but I have no idea how to backtest options e.g. what was the OTM price on 21st Oct etc.... I use Tradestation if that is of any use.

Please help point me in right direction, I am new to options.

Thanks
Koms
 
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