|
PureBytes Links
Trading Reference Links
|
I am hesitant to jump into this given the negative posts. I am especially
hesitant to jump in because it involves debating with Gary Fritz, and he is
not a person I would choose to debate with because I generally agree with
almost everything Gary posts. But here it goes.
>But ignoring that, I think his Fixed Ratio approach is bogus. IMO
>his entire premise is flawed: he looks at the per-contract profit it
>takes to move from 1 to 2 contracts, and he says that it should take
>the same per-contract profit to move from X to X+1 contracts. I.e.
>if you need $10k profit to move from 1 to 2 contracts, you should
>need $10k profit **per contract** to move from 100 to 101. You'd
>need $1M total profit to increase by 1 contract.
Yes, but you are talking about position sizing changing from 1 contract to
100 contracts. That is a huge increase. In the real world, how many traders
start with trading single contracts and actually end up trading 100
contracts? This would reflect a huge account increase.
You are saying that this trader has determined he wants $10K profit before
moving from 1 to 2 contracts. I think it needs to be clear that it is the
trader who makes this initial decision, not the Fixed Ratio strategy. This
$10K is what Fixed Ratio calls the "delta" parameter, which essentially is
the aggressiveness parameter. It is the trader's decision what to use for
the delta, and usually the decision would be based upon historical combined
portfolio drawdown.
So, the trader decides that given the risk dynamics of his portfolio, he
chooses $10K profit as the amount for when he wants to add a second
contract. In other words to add a single additional contract. This is an
initial decision the trader makes based upon the size of his portfolio, how
aggressive he wants to be, etc..
If $10K is the tolerable risk for 1 contract, then for 100 contracts the
tolerable risk is $10K * 100 = $1 million. From this, it doesn't sound so
radically unreasonable to use $1 million as an increment for increasing
position size.
I am not saying the above is a money management strategy. I am only trying
to put the scope of the numbers being discussed into perspective. I am not
sitting down and running any historical testing, but it strikes me that by
the time this account moves from trading single contracts to 100 contracts,
I would think it is going to be a huge many million dollar account.
Is the glass half full or half empty? If you want to be less aggressive in
the early stages, adjust your delta parameter to be less aggressive.
However, that will lead to also being less aggressive as equity increases.
So, the criticism of being too aggressive in the early stages will change
to a criticism of not being aggressive enough in the later stages.
Jones does discuss this problem of Fixed Ratio not being aggressive enough
as equity increases in Chapter 16 "Money Management Marriage". He proposes
that in the later stages to consider switching from Fixed Ratio to Fixed
Fractional. To quote Jones, "At one point, it is better to switch from
trading the Fixed Ratio method to the Fixed Fractional method."
Also, there is more to the Ryan Jones book than the position size increase
formulas that we are discussing. He also discusses ways to handle position
size pull backs in a drawdown (although those same concepts could be
applied to Fixed Fractional).
My opinion is that there is no one "best" money management strategy. It
depends on what the trader wants to accomplish.
It strikes me that Fixed Ratio is appropriate for an individual trader with
a smaller account. Say an individual trader decides to start trading a
portfolio of 5 commodities with a $30K account. His perspective is that
this $30K is risk capital. He chose $30K because that is what he is willing
to lose. In other words, he is willing to go through a 100% drawdown (the
entire $30K) before giving up.
However, say the account doubles to $60K. At this point, I think the trader
would not want to lose the entire $60K. Say the account increases to $300K.
At this point, I think the desire to not lose the entire $270K in profits
would be that much stronger. When the account reaches $1 million, obviously
you would have to be crazy to risk losing your entire $1 million in profits
via a 100% drawdown from that point.
My point is that I think this individual trader is willing to take much
higher risks with his initial $30K account, and his percentage risk
tolerance based upon account size progressively declines as account equity
increases. Mark Johnson wrote an excellent article about this in Club 3000
back in 1999 (Club 3000 99.04). I recall he also posted a subset of the
article to the omega list. Rather than Fixed Ratio, Mark Johnson was
talking about varying the percentage used in fixed fractional depending
upon decreasing risk tolerance as account equity increases. But the general
philosophy is the same.
For this individual trader with the initial $30K account, Fixed Ratio might
be a good money management approach because it does exactly what he wants.
It takes higher risks in the beginning, then progressively risk levels off
as account size grows. This fits with decreasing percentage risk tolerance
as the individual's account grows. This is as opposed to fixed fractional,
which will use the same risk percentages throughout the life of the account.
Now, take the example of a money manager starting out with $1 million to
trade. It is a completely different situation. There is no way this money
manager would decide he is willing to tolerate 100% drawdown from his
initial $1 million account equity. In fact, once he hits 10% drawdown, he
might find himself looking for a new job. This money manager would probably
choose a fixed fractional approach because he needs to control risk from
the beginning.
My viewpoint is that Fixed Ratio is all about account growth, where Fixed
Fractional is all about controlling risk. Which makes more sense for one
trader or another, or whether some completely different strategy would be
best, depends on your goals.
>Moving from 1 contract to 2 isn't equivalent to
>moving from 100 to 101; it's like moving from 100 to 200!
Saying 1 to 2 should be the same as 100 to 200 is exactly describing fixed
fractional.
> I think
>simple fixed-fractional approaches handle the position sizing much
>more logically.
I have no argument with you saying fixed fractional is best for your goals,
but other people might have different goals.
>What really honks me off, though, is the way he cooks the books to
>make his approach look good. Fundamentally what he's doing is using
>very high leverage when the account is small, and backing off as the
>account gets big. This has the advantage that it gets the small
>account off the ground & running quickly. But it also exposes you to
>a lot more risk early on. He uses all kinds of examples to show how
>the FR approach can take a $X per contract loss with a much lower
>drawdown than FF -- but he constructs his examples so that drawdown
>happens AFTER he's scaled back the leverage. He conveniently
>neglects to mention that the FR approach would BANKRUPT you if that
>same per-contract loss happened early on with higher leverage.
The examples may be cooked, but that does not mean the Fixed Ratio strategy
is flawed. It just means Jones may have chosen bad examples.
>Add to that a host of logical and math errors,
This I agree with. Some of the explanation is very difficult to understand,
and the problem is compounded by errors in examples. It was posts to the
omega list which helped us finally understand (actually, credit where
credit is due, it is someone I am working with who worked through the
problems, not me).
If before publishing the book Jones has found some decent proofreaders and
some peer reviewers to point out things like cooked examples, it would have
been a better book. But I am not ready to give up on Fixed Ratio because
the book could have been written better. With all the flaws, I think the
book has some good ideas, and I think that there are others who have
studied the subject more than me who agree with this.
>Jones traded himself into a 95% drawdown, presumably using his own MM
>techniques. I can't verify the accuracy of that claim, but it
>wouldn't surprise me at all. As I explain below, all it takes is a
>drawdown ***early in the account's life, while Fixed Ratio has you
>using dangerously high levels of leverage***, to produce results like
>that.
This is anecdotal evidence at best. Of course, any money management is
useless if underlying systems do not perform. It is plenty easy to go
through a 95% drawdown trading single contracts. Maybe Jones isn't a good
system designer. Or maybe he isn't a good trader, unable to execute his
systems. Or maybe he used poor judgement in his initial choice of delta (as
you say, he was too aggressive in the early stages). This would be an
argument to not choose Jones as a money manager to trade your money, but I
don't think it is proof that his money management concepts are flawed. It
seems it is common that different people have different skills. Some are
researchers, some are traders. Although this trading record is horrible, it
isn't proof that his ideas about money management are incorrect.
Bob Bolotin
|