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Re: Money Management Stops



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Mickey was the one that was refering to the roulette wheel.   If I remember 
the rules right,  for picking the right number, you have a 36 to 1 payout, 
with a 1 in 38 chance to win.  The house has the advantage.  If the gambler 
plays long enough, he will lose everything (negative expectancy),  If the 
House plays long enough, the house will take all (positive espectancy).  The 
House is taking a risk, while the gambler is just gambling.  To me, the 
difference between gambling and risk is whether there is positive expectancy. 
 It is entirely possible for a bunch of gamblers to enter the house and have 
a winning streak that breaks the house and I'm sure that has happened to some 
gambling establishment, somewhere or sometime.  Capitalization (money 
management) is important here.  Diversification is also important.  A Casino 
having many different games is essentially diversifying.  If they only had 
one game, and played against a high roller, the house may be at great risk of 
losing everything even though they have a positive expectation.  The casino 
industry has used many math wizards to develop games and house rules, 
especially the electronic slots, to extract the most money from people and 
keep them coming back.  I'm sure they test market their slots, to see how 
people react.

The trading analogy here is to use trading systems with positive expectancy, 
diversify and use reasonable money management.  You also might want to have a 
rule that, if you lose a certain amount of capital, due to a losing streak, 
you might stop trading.  We are trying to trade with an edge, just like the 
casino, with both diversification and money management. 

Sure trading is different, but the hazards are different and the rules are 
frequently broken.  Luck (random events) plays a role in trading, ie. taking 
a risk, even for system with a positive expectation.  Let's say you have a 
great system and you put all your money into one great stock, like MSTR, and 
then they announce the have an problem with their accounting.  You get 
creamed, despite the great trading system.
Bad luck, Fraud, the result is the same.

Or consider a beginner starting out with a good system that only takes long 
trades and the jumps into the market right at the peak.  They get clobbered, 
even though they have a good system.  Just bad timing or bad luck, they know 
what a losing streak is.

Guy, I don't know what your longest losing streak was, but lets say its is 
four losing trades.  With very poor money management, a person could manage 
to lose most of his capital in four bad trades.  And four bad trades could be 
topped by five bad trades down the road. There is nothing in nature that says 
the losing streak must end.   I think most experienced traders, develop a 
sense of how the market is and take trades accordingly.  For example, J. 
Livermore, would test the waters with small positions, before committing the 
bulk of his capital.  He did go broke a few times though (losing streaks?).  
You and I have both met people who have had hard luck all their lives.  ( A 
life long losing streak and there are other people that are incredibly lucky 
all their life)

I'm currently a stock trader, and I'm mostly trading high growth stocks, like 
the ones that just got clobbered.  I'm continually testing my main trading 
system on different stocks to see how the work on different stocks.  I have 
seen quite a variation in results.  (fat tails?)  Diversification  and 
careful money management keeps me from getting hurt too bad by those fat 
tails.

Recently, I watched a person start trading, for the first time, this year 
with a pretty good trading system.  He aggressively took one loss after 
another until his capital was reduced by 25%.  This was a combination of bad 
luck and lack of experience.
I guess it never occurred to him that a long system wouldn't perform well in 
bear market.  Had his money management skills been worse, he could have 
essentially lost all of it.    

Guy, I don't know if you have ever watched a new trader start out trading, 
but you quickly realize that you have a lot more knowledge that is coming 
into play that is interacting with the system.  The beginner doesn't know 
what he doesn't know.

This really is a tough complex game.  (or as you say, a hard way to make easy 
money)

I hope that Mickey realizes, that just because you have observed four losing 
trades, that the fifth may not be a sure winner.  Betting the farm on the 
fifth trade may work for a while, but eventually that fifth loser will bite 
you.  As Ralph Vince has said many times, "you are only as good as your worst 
trade".

Kevin Campbell


In a message dated 4/17/00 8:48:53 PM Central Daylight Time, grt@xxxxxxxxxxxx 
writes:

> Kevin
>  
>  I'm not sure whether I agree with any of the gambling analogies when used
>  for comparison to trading the markets.  My primary reason for this is that
>  in gambling (roulette and craps are examples) your analogies are 100%
>  correct, IMHO.  When compared to blackjack, there are some variances based
>  upon the play of players before and after you that impact the deck and the
>  play.
>  
>  When compared to trading the market, I don't think these analogies are
>  applicable at all.  Again, that's just my opinion.
>  
>  I'll agree that it's possible to have 1,000 events go against you in a row
>  and then have 1,000 go for you in a row.  However, if in testing this
>  system, you ever decided to trade it, you would be broke in no time at all.
>  
>  If on the other hand, you develop a system that is capable of 80% 
profitable
>  trades, proper testing would give you some idea as to the distribution of
>  these losing events.
>  
>  In our case, even when we develop a new weighting schema, we back test the
>  system for 6 months, 5 years and 18 years.  While we're primarily 
interested
>  in the last 3 years, we also need to see how the system would have done in
>  the real world over a longer period of time.  Rather than manufacturer a
>  random list of numbers going back many years, we just use the actual
>  market's performance over that longer period.  In our case, again, large
>  losses are exceedingly rare, thank goodness.  Repetitive losses are also
>  very rare.  On average, for the past 15 years, we average no more than 6 or
>  7 losses a year while still maintaining our minimum profitability ratio of
>  over 70%.
>  
>  If in back testing, we ever encounter repetitive losses of the type you
>  describe, even while still maintaining good profitability, we would never,
>  ever trade it.  In all of our back testing, we take repetitive losses into
>  consideration as well as the system's profitability.  A system that wipes
>  you out without giving you the opportunity to make a "come back" is hardly 
a
>  system.
>  
>  Regards,
>  
>  Guy
>  Fax (630) 604-1589
>