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Al,
Your ATR positionsize logic is appropriate assuming that your measure
of risk as a % of Equity is based upon "individual trades" as the
benchmark. But does that approach translate into a predictable Equity
drawdown measurement where "Portfolio trades" are measured?... ie.
where major mkt downturns result in high numbers of sequential 1%
trade losses.
My own backtesting / trading experience is based upon measured
Portfolio trading results which have turned my attention to other
measurements.
What I have found to perform best in my own swing trading systems is
a well balanced combination of the following:
Avg days held for profitable trades is more than twice that of avg
days held for unprofitable trades. (This translates into risk
management where losses are cut early.)
Avg profit per profitable trade is more than twice the value of avg
loss per losing trade. (This translates into risk management where
winners are allowed to 'run'.)
I do measure % winners versus % losers... and some systems need a 60%
winning percentage to 'shine'... while other great trading systems can
do very well indeed with only a 40% winning percentage because the
profits of the winners overwhelm the losses from the 60% that lose.
The main focus is to control (and limit) losses.
The next major release of AB will have 'Portfolio trading
measurements' which is the missing factor for most folks today.
Hopefully, release 4.5 will be an 'eye opener' for AB Users.
In all fairness to your approach, I have not backtested ATR
positionsizing (which I intend to do). But I have backtested limiting
losses to a fixed percentage, and to date, fixed percentage stop loss
strategies are inferior to other stop loss methodologies.
Regards,
Phsst
--- In amibroker@xxxxxxxxxxxxxxx, "Al Venosa" <advenosa@xxxx> wrote:
> b,
>
> Thanks for the post. I have to chime in here because, although I
agree with your overall treatise on money management, I believe you
can achieve your desire to increase profits without sacrificing risk
simply by setting your stops based on volatility (ATR). When you do
this, you equalize all the stocks in your portfolio, at least in the
beginning, so that your profit and loss potential are approximately
equal across all stocks while your risk stays fixed at x% per stock
(set x to whatever you like or can tolerate). So, if Stock A has a
high volatility and Stock B a low one, you simply buy less of Stock A
and more of Stock B to compensate for the difference in volatility.
Here's an example: assuming your equity were $100 K for ease of
calculations and taking your $100 stock (call it Stock A) as one you
want to buy, if its ATR is, say, $3, your risk tolerance is 1% of
equity, and your stop based on your system is, say, 2*ATR below the
buyprice, then you would buy 1000/2*3 or 167 shares ($16,666
commitment). Now, suppose you also want to buy Stock B, whose price is
$50 and ATR is 1. You would buy 1000/2*1 or 500 shares, commiting
$25,000 of equity. Notice that you commit more equity to the lower
volatility stock (its ATR is 2% of the price vs. the higher volatility
stock whose ATR is 3% of the price). Now you have 2 stocks in your
portfolio that will have approximately the same profit and loss
potential based on price movement because you have equalized your
trades based on their volatility. This, to me, makes a lot more sense
than basing your max stoploss on a fixed dollar amount based on a
trend line or something like that.
>
> Now, I have a question for you. What do you mean when you say you
buy a basket of stocks rather than individual stocks? Do you mean
indices or industry groups like biotech, semiconductors, etc.? If so,
then you can treat those indices just like stocks and use position
sizing as above, based on ATR. If you mean mutual funds, you cannot
calculate ATR since you need OHLC data. But you can calculate standard
deviation of NAV over the last x days to give you an estimate of
volatility, which could serve very well as a substitute for ATR. If by
basket you mean something else, please help me understand what you
mean. I ask because I cannot envision why you cannot use position
sizing for any type of trading system.
>
> Thanks for the interesting discussion.
>
> Al Venosa
> ----- Original Message -----
> From: b519b
> To: amibroker@xxxxxxxxxxxxxxx
> Sent: Tuesday, September 23, 2003 12:03 PM
> Subject: [amibroker] Position Sizing, math, and profits
>
>
> Herman,
>
> To understand what various authors mean by position sizing you need
> to distinguish between the amount of money invested in a trade and
> the amount of money "at risk" in that trade. The amount of money at
> risk may only be 10%, 5% or even just 2% of the money used to buy a
> stock.
>
> Below is a copy of a post I made about this on another discussion
> board.
>
> b
>
> -------copy-------
>
> Subject: Managing Risk & Increasing Profit (was How to Test VV
> strategies)
> http://groups.yahoo.com/group/vectorvestonlineusersgroup/message/2932
> 8
>
> --- "Dennis Fluegel" <dfluegel@xxxx> wrote:
> > "Absoluely brilliant!. You've nailed it!
> > ... your post ... should be required reading."
>
> Thanks for the kind words. That post addressed risk management for
> just one of several investing approaches. Those principles would not
> be appropriate to all types of investing. Thus the disclaimer
> stating "You are also responsible to ensure that your education is
> sufficient for the type trading you plan to do."
>
> You mention that many of the books on risk management seem to
> contradict each other. In addition to differences of personal risk
> tolerances of the authors, the apparent contradictions may arise
> because the books focus on very different trading approaches.
>
> Risk management formulas for trading in the "futures" market will be
> very different than those that focus on trading Options, which will
> differ from those trading stocks. Even among those trading stocks,
> there are key differences between trading stocks as "individual"
> entities and trading stocks as groups or "baskets". My personal
> trading approach is along the lines of the "basket" approach, and
> thus my prior post related to managing risk (and increasing profit)
> for stock baskets using market trend signals to time entries and
> exits.
>
> Books on risk for futures trading have to take into account the
> massive leverage (much more leverage than buying stocks on margin).
> So the formulas they suggest will have very low thresholds.
>
> Many books on risk management for stocks do not address risk
> management approaches for baskets of stocks. Instead they focus on
> managing risk (and thus maximizing profit) when stocks are not
> bought and sold as a group, but individually with different entry
> dates (usually based on a timing signal based solely on a stock's
> chart). In such approaches there is a lot to be said for a "position
> sizing" approach to risk management.
>
> Position Sizing is a fascinating study in how mathematics can
> influence strategy, execution, and profits. The results can be
> surprising. For reasons to be explained, I personally only use it
> occasionally, but I find it fascinating.
>
> Generally position sizing assumes one can find a "logical" place to
> set a stop loss exit. Finding a logical stop loss point can be done
> if entries are timed, not by the market trend, but by an individual
> stock's price chart. The timing decision to enter is based on
> recognition of a chart pattern. (A great book on how to recognize
> and trade chart patterns - and which not to play! - is Thomas
> Bulkowski's Encyclopedia or Chart Patterns). Typically a "logical"
> place to set a stop loss would be the price point when one would
> know that the chart pattern has broken down. Without a pattern in
> place, a chart reading trader has no idea where the stock price may
> go and thus no reason to expect it is more likely to go up than
> down -- certainly if one has no clue about a stock's direction it is
> time to exit that trade! One can use trend lines, "neck lines", and
> support and resistance lines to set stop exits. Generally one sets
> the stop exit order a bit below the price signal (to avoid being
> food for market makers who may try to trigger obvious stop levels).
>
> Once one has decided upon a Stop Price, then the math is fairly
> simple. Take the distance in dollars from one's Entry Price to the
> Stop Price (add a bit more for "slippage" and commissions). That
> amount is the risk per share (RPS). One also selects a maximum
> single loss percentage of one's total trading capital. Common
> percentages suggested are 1%, 1.5% and 2%. Some authors say 2.5% or
> 3% single stock loss risks are for "gunslingers". These numbers are
> combined to tell a person what "position size" to use for an
> individual stock entry (ie, how many shares to buy).
>
> So if one plans to buy a $100 stock and sets a "logical" stop loss
> exit at $98, the distance is $2 a share. Add perhaps 50 cents for
> slippage and commissions and the RPS is $2.50. If one has a trading
> account of $20,000, then a 2% maximum single loss (MSL) would be
> $400. What is the position size formula? MSL/RPS = $400/$2.50 = 160
> shares of the $100 stock. That is a $16,000 commitment to a single
> stock!!! So, a 2% maximum single risk is not necessarily a limiting
> factor.
>
> By the way, those who trade this way usually have couple additional
> rules. One additional rule will limit the a maximum percentage to be
> put into a single stock (perhaps 25% or 20% or less), so they would
> not put over half their funds into a single stock. In addition some
> will have a 6% aggregate exposure rule. So they have 3 trades in
> play each with a 2% outstanding RSP, they will not enter any new
> trades (even if they have cash sitting in their account). However,
> if a stock goes up as hoped, one can replace the stop loss exit
> order with a trailing stop order set above the entry price -- and
> thus, according to this line of reasoning, that trade's RSP is now 0
> (zero). That reduces the aggregate outstanding risk to less than 6%,
> so new trades can be entered until the aggregate risk gets back to
> 6%. That gives the basic idea of one particular approach to risk
> management when stocks are traded individually.
>
> What if that $100 stock has moved from the time you decide to buy it
> to 102.50 by the type you have typed in your buy order? Well, one
> should reduce the number of shares to compensate for the fact the
> RPS is now 102.50 - 98.00 = 4.50 plus the 50 cent slippage = $5.00.
> Thus the order should be for $400/$5 or 80 shares. What if the
> stocks dips to 98.50? Well, that would be a RPS of 1.00 (remember
> the 50 cents slippage) so the math is 400/1 = 400 shares or $39,400.
> Of course the secondary rule of only 25% in a single stock would cap
> this at a lower level.
>
> What if the stock dips to 97.50? Walk away. The stock has broken its
> chart pattern and is "misbehaving".
>
> If one can set a logical "price target" based on the chart pattern
> (Bulkowski's book has some insights on this), there is some
> additional math that can be used to rank which trades are the most
> profitable to take. In general terms, it is Possible Realistic
> Gain / RPS. One could call this a "Risk Return Ratio" (RRR) but I
> like to reorder the words to be "Reward/Risk Ratio" - just the way
> my mind likes to name things - the concept has not changed.
>
> If you only had enough aggregate risk space left to take 1 new
> trade, would you take trade A with a potential gain of $8 or trade B
> with a potential of $12? It would all depend on what the RSP is for
> each trade. If the stop exit is very close to the entry price for
> trade A but far away for trade B, then trade A would have the higher
> RRR. Taking trade A would give a smaller percent gain on the trade
> but the dollar gain would be higher (because the closer stop would
> allow a larger position size). Thus trade A would bring in more
> profit than trade B. Math is amazing!
>
> The math and strategizing is neat stuff. But it is almost totally
> irrelevant to my trading - because my general approach is to trade
> stocks as basket based on market timing rather than individually.
> Occasionally (and just for "fun") I will do some chart reading and
> calculate some RPS and RRR numbers. Very occasionally I might place
> a trade based on this.
>
> As for my preferred approach, position sizing does not appear to be
> applicable due to the lag of my market timing signal. As a result
> the stocks that my strategies pick are generally so far away from
> any "logical" stop when the market timing signal goes off, that I
> (currently) do not see an advantage to using RSP to position size
> and RRR to rank. However, I am keeping an open mind about this.
> Because if one could find a way set individual exit stops (not
> percentage based, but dollar based or perhaps ATR based), then one
> might be able to increase profits without increasing risk.
>
> b
>
>
>
>
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