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Rudolph,
The mathematics involved in Optimal f are based on the following:
- you need to have a history of prior trades for your system
- you know the winning/losing percentage of trades for your system up to the current trade being placed.
- winning and losing trades are used to determine a "holding period return"
- the holding period return is used to calculate a 'terminal wealth relative" using the optimal contracts to hold (optimal f)
The assumptions behind this are:
- there is a reasonable expectation that the system you are using for trading can be repeated
- the system you are using has statistically verifiable rules
- the method of execution is mechanical
- you want the maximum growth of the account regardless of the increased risk.
Some of the potential problems with this method are:
- optimal percentages often come out to fractional number of contracts (i.e., 4.23) so you must round up or down.
- the system being evaluated is executed without variance (no human emotion, skipped trades, slippage always the same, etc)
- the optimal f number is continually recalculated based on the last trade, W/L percent, capital available, etc.
- the drawdowns can cause a trader to stop using the system - increased profits mean increased drawdowns in absolute dollars.
Optimal f deals in percentages, people often do not.
There are a number of books on money management which go into detail about the various methods and their risks. I recommend you
look at these in addition to Ralph Vince's book which goes into the mathematics of Optimal f
Quantitative Trading and Money Management, Gehm
Money Management Strategies for Futures Traders, Balsara
Regards,
Ed Winters
----- Original Message -----
From: rudolf stricker <rst@xxxxxxxxxxx>
To: <metastock@xxxxxxxxxxxxx>
Sent: Saturday, July 03, 1999 7:02 AM
Subject: Re: Formula for Optimal f needed
> On Thu, 1 Jul 1999 17:57:32 -0400, you wrote:
>
> >Spreadsheet for optimalf from Futures Mangazine attached.
>
> Ed, thank you very much for posting the Excel sheets on Optimal f
> calculation from Futures Magazine!
>
> Even if I have to look more into the details of the procedure to get
> the idea behind the sheets: Can you (or someone else) give some hints
> about the general outline of the Optimal f method?
>
> My first impression is:
> Based on a test set of "historical" data, a probability distribution
> for wins & losses is constructed, which reflects the capabilities of
> the trading system and the characteristics of the market under
> consideration. From this, the result for new investments is estimated,
> but how is this done? - What is (in simple words) the criterion to
> select an optimal re-investment factor?
>
> Some general remarks on the Optimal f method:
> Seemingly, it follows the approach, that there is no other information
> about risk than "historical" trades. Imo, this is not true in
> general, especially when it comes to well-known side effects e.g. from
> political events, etc.
> Additionally, rapid market changes cannot be condensed easily in
> "historical" data. So this "historical" approach has some general
> drawbacks, imo.
> Finally, the trading system (like mine) often gives a basic estimate
> for something like "risk" for every upcoming trade, and I would like
> to combine this "known risk" with the "statistical risk" (like used in
> the Optimal f method) for my money management. - Any pointer in this
> direction?
>
> mfg rudolf stricker
> | Disclaimer: The views of this user are strictly his own.
>
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