Fw: Optimal f code for Tradestation Part I

["John Manasco" <john@xxxxxxxxxxx>]

----- 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 I


> At 1:34 PM -0400 6/9/00, CRLeBeau@xxxxxxx wrote:
>
> >I agree.  Prudence dictates that we must always assume that our biggest
loss
> >(and biggest winner) are yet to be seen.  However, if we decide to trade
at
> >less than optimal f, then it is no longer the "optimal" bet size and
maybe we
> >should be using some other formula.
>
>
> Economists have long used the concept of "utility curves" to show
> investment preferences.
>
> There is a simple chart I use to illustrate many of these concepts.
> Two versions are attached. The first one, Chart1, is an expanded
> version of the second, Chart2, for clarity. (This post is split into
> two parts to avoid exceeding the size limit on one post.)
>
> Using the S&P 500 index for the past five years, I postulated a
> simple trading system:
>
> At the end of each week you determine the value of your account, then
> multiply it by a "leverage factor", then invest that amount in the
> S&P 500 for the following week, borrowing the amount needed to do so.
> Using a leverage factor of 1.0 is the same as Buy/Hold. Using a
> leverage factor of less than 1.0 means investing only part of your
> account in the market. Uninvested funds draw 5% interest and you pay
> 7% interest on the "margin loan". The question is "what would your
> account have done over the past five years as a function of the
> leverage factor". (This is clearly a "fixed fractional" system since
> the "leverage factor" is assumed to be constant over time.)
>
> The attached charts shows a plot of annualized return vs. annualized
> standard deviation of returns with the various values of the leverage
> factor shown as points on the curve.
>
> Referring to the first chart, if you are a "little old lady" who
> needs 8% per year to live on, then your utility curve might be as
> curve A. All points on curve A are equally useful to her (constant
> utility). (There is a family of such curves of different utility to
> her.) The point where her utility curves intersects the investment
> curve is the optimum operating point for her, realizing about 8% per
> year by investing only a small portion in the market and keeping most
> of her money in T-Bills (or CDs, etc.). In effect, it would take a
> very big incremental return for her to assume more risk that she has
> to to get her 8% return.
>
> But if you were a 35 year old engineer saving for retirement, you
> might have a utility curve such as in curve B. You would prefer
> higher returns and could absorb deeper corrections associated with
> using leverage because you are in the market for the "long term".
>
> (Continued in part II)
>
> Bob Fulks

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