RE: Risk of ruin, amount per trade formula?

["Guy Tann" <grt@xxxxxxxxxxxx>]

Mark,

While developing a trading methodology is fine, we take a slightly different
approach.  We develop the trading system first.  Once that's done and we
have paper traded it for a period of time we will then work on stops,
investment amounts, etc.  Nothing beats paper trading.  Most importantly, be
honest with yourself as when you're the only one rationalizing the results,
it's very easy to say, "Oh, I wouldn't have done that" and vice versa. :)

Your trading approach will depend upon how good your system really is.

Guy

Paranoia...you only have to be right once to make it all worthwhile!

-----Original Message-----
From: owner-metastock@xxxxxxxxxxxxx [mailto:owner-metastock@xxxxxxxxxxxxx]On
Behalf Of Mark Thompson
Sent: Tuesday, July 11, 2000 8:51 AM
To: metastock@xxxxxxxxxxxxx
Subject: Re: Risk of ruin, amount per trade formula?

Thanks so much for your explanation on leverage between stocks and futures.
I do not trade futures and thus do not have a very firm grasp of the the way
that they are traded.  Your step by step clarification helped a lot.

To expand on what I was trying to communicate earlier about finding an
optimal amount to invest in stocks, my plan is to try to combinte the
concept of maximum adverse excursion with fixed fractional investing to come
up with a money management formula for stocks.

Maximum Adverse Excursion (MAE) says that for a particular trading system
there is an optimim place to put a stop under a trade of a particular market
or equity that will allow winning trades to continue and will stop losing
trades from becoming big losers.  As an example if AOL goes against "Trading
System A" by more than 12% it is likely to be a losing trade thus I will
stop out if it hits that point.

Now building that into my logic for money management, I select a percentage
of my total portfolio that I want to risk on one specific trade.  Since
stocks can have catastrophic losses I would never want to "put all of my
eggs in one basket" so to speak and thus I will diversify my trading capital
into several stocks.  If I say that I never want to risk more than a
percentage of my capital on one trade (lets say 2% for example) and I know
my MAE and my current equity I can then determine the trade size which will
accomplish my goal.
Example:
$100,000 Equity
10% MAE
2% Max loss

($100,000*.02)/10% = $20,000 to be invested in each individual trade.

Now, I want to determine how many stocks I can buy with investment and
margin  In this case it would be
($100,000*2)/$20,000 or 10 stocks and the total risk I would incur would be
20% of my equity.  Since I am limited by the 50% margin limit of stocks, I
cannot exceed this amount.

The question in my mind now becomes, is 20% less than or equal to the
optimal amount that should be traded based on optimal f or whatever to
maximize my return.

I hope that this better explains what I am thinking.  Any ideas from here or
am I just indulging in mental gymnastics?

Mark