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Sorting out the criteria for a coherent money management plan is a
complex, detailed job. Using a spreadsheet to keep track of the logic
helps ensure nothing has been omitted.
With a little planning, one can develop a logically sound money
management system. Historically, too much emphasis has been placed on
the development of profitable entry and exit rules, whereas the
determination of the proper number of contracts or shares to trade
(Position Size) has been treated as a distant afterthought.
Here are some Trader-Defined Criteria:
Max # of Open Positions allowed: 7
Max % of Closed Equity to risk/trade: 0.10
Max % of Transaction Costs to anticipated profit: 0.20
Max % Loss permitted/month: 0.05
Max % to risk if closed equity drops 5%: 0.02
Max % to risk if closed equity drops 10%: 0.01
Max % to risk if closed equity drops 15%: 0.0075
Max % to risk if closed equity drops > 15%: 0.0050
An individualized money management algorithm (using a spreadsheet
program such as Microsoft Excel) will control the equity growth of
any positive-expectancy system as a direct function of using correct
position sizing. Risking too large a portion of trading capital per
position will eventually cause even the most profitable trading
system to fail.
The second advantage to developing your own position-sizing strategy
is to preserve trading capital during periods of extended drawdown or
losing trades. This saves you the money to trade when things finally
turn around. Unfortunately, many traders inadvertently lose their
hard-earned trading capital as a result of improper position sizing.
This becomes painfully obvious when they have risked too much capital
over an extended series of losing trades. -- Ray Overholser, O.D.,
is a private trader in Gainesville, FL. He is completing a graduate
business degree at the University of Florida, with the goal of
opening a hedge fund based on his research in technical analysis and
money management. He plans to launch an online newsletter at
www.WealthByStrategy.com. He can be reached by E-mail at
stocktrader@xxxxxxxxxxx
A good risk index can be useful in the selection of stocks, funds,
and trading systems. Here, then, is the ulcer index, why it is
superior to the standard deviation statistic, and how it can be used
in a variety of personal investing or professional money management
applications.
What is risk, and how is it measured? Risk is commonly defined in
terms of the volatility of an investment's total return or the
volatility of the price. The standard deviation is a good measure of
volatility, since it measures the amount of variation around the
average and is probably the most widely used measure of financial
risk. But the standard deviation has two weaknesses for financial
instruments. First, it measures the variation from the average in
both the up (good) direction as well as the down (bad) direction.
Second, the standard deviation does not distinguish between short or
long sequences of losses. Investors are only concerned about downside
risk (or the potential for losses), whereas upside changes or rapid
increases in value create profits.
The ulcer index uses only the retracements from the price peaks in
the calculation. The standard deviation may still be the most widely
used because it has been around longer than other risk indices and
most computer programs have the capability of calculating it.
However, there is another measure of risk, superior to the standard
deviation: the ulcer index.
Peter G. Martin and Byron B. McCann are credited with the creation of
the ulcer index. They describe it in their 1989 book, The Investor's
Guide To Fidelity Funds. (To see the calculation for the ulcer index,
see the sidebar "The ulcer index.") In contrast to the standard
deviation, the ulcer index has none of the aforementioned weaknesses
since it calculates retracement, which is the tendency for values to
fall from previous highs, by measuring the depth of the drop and the
time that it takes the performance measure to recover to the original
level.
Another advantage is that the ulcer index doesn't measure downside
changes from the average but from the previous high. The measurement
includes every drop in performance in the period being studied. Funds
or trading systems with high ulcer index readings should be avoided
unless they have such exceptionally high returns that the risks are
justified. In addition, dividing returns by the ulcer index produces
a useful risk-adjusted return measurement. -- Gary Elsner, Ph.D., is
editor of the mutual fund timing newsletter Achieve Profits (Website
http://www.AchieveProfits.com). He may be reached via E-mail at
gelsner@xxxxxxxxxxxxxxxxxxx
rgds, Pal
--- In amibroker@xxxxxxxxxxxxxxx, "palsanand" <palsanand@xxxx> wrote:
> Hi All,
>
> I am using the following formula for position size:
>
> Available_Equity = (0.1 * Usable_Margin);
>
> Position_Size = Available_Equity/(Max_Drawdown_Percentage);
>
> Typically, you can determine Max_Drawdown_Percentage using MCS
(Monte
> Carlo Simulations)
>
> For e.g, if Usable_Margin is $5000, then
>
> Available_Equity = 0.1 * 5000 = $500 and
> if Max_Drawdown_Percentage = 20% = 0.20
>
> Then, Position_Size = $500/0.20 = $2500
>
> So if you have 5 underlying instruments you want to trade, you
would
> invest $500 per instrument getting instant diversification.
>
> Regarding the use of volatility in position sizing, I find that it
is
> automatically taken care of depending on at what price you enter
the
> market relative to the current price, i.e, at MOO or at support or
> resistance.
>
> For e.g, if you have a long signal but the current price is below
> MOO, then enter at support, else at MOO Limit Order(current price >
> MOO) and similarly if you have a short signal but the current price
> is above MOO, then enter at resistance, else enter at MOO Limit
Order
> (current price < MOO), with the assumption that MOO is often the
best
> price to enter and that the instrument opens at the same price
where
> it closed the previous session which is the case atleast for the
> FOREX market.
>
> Any comments/constructive criticisms appreciated.
>
> rgds, Pal
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