Fw: Optimal f code for Tradestation Part II

["John Manasco" <john@xxxxxxxxxxx>]

Ok, four emails instead of three.

----- Original Message ----- 
From: Bob Fulks <bfulks@xxxxxxxxxxxx>
To: John Manasco <john@xxxxxxxxxxx>
Sent: Monday, July 10, 2000 9:28 AM
Subject: Re: Optimal f code for Tradestation Part II


> 
> On Optimal_f
> ------------
> The point where you get the maximum possible return from this
> investment is at the top of the investment curve (see second chart).
> This point gives the maximum "terminal wealth relative" as Ralph
> Vince calls it and is the point he calls Optimal_f. Anyone operating
> at this point would have to have a utility curve that is a flat
> horizontal line.
> 
> A flat utility curve would imply that you value return above all
> else, no matter what risk is involved. No rational person would have
> such a utility curve so this is one reason why operating at Optimal_f
> is not popular. At that point on the chart the leverage factor is
> about 7 for this "system" and at one point in the five years period
> you would have lost 70% of your account value in one week. How many
> people would have stayed in at that point to see the recovery?
> 
> At a leverage factor of about 15, you would have "gone broke" in that
> correction week, losing all of your account. The "gone broke" point
> is fairly far from the Optimal_f point because this is a pretty lousy
> trading system with a Sharpe Ratio of less than one. With a better
> system, the "gone broke" point is only slightly higher than the
> Optimal_f point.
> 
> 
> Futures Traders use of Leverage
> -------------------------------
> A futures trader inherently is using leverage. One S&P 500 contract
> is worth 250 * $1400 = $350,000 now. With an account size of $35,000
> today he would be using a leverage factor of 10 on this "system",
> which would be well to the right of the peak, which would be stupid.
> Operating to the right of the peak increases variability and
> decreases returns. Operating at the peak with this "system" with a
> leverage factor of about 7 would require an account size of about
> $50,000 today.
> 
> Summary
> -------
> So different people have different utility curves depending upon
> their personal circumstances. The optimum operating point is where
> their utility curve just touches the curve describing the
> market/system combination they are using. No rational person would
> operate at the peak of the curve, the Optimal_f point, since that
> would imply a utility curve that values only return with no
> consideration for risk.
> 
> Bob Fulks

Attachment Converted: "f:\eudora\attach\Chart21.gif"