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>I came across the Kelly formula, the method wherein one can increase their
>stake in the safest possible manner given a 51% edge.
>Snip<
>This money management system might be valuable for commodity traders, it has
>helped my trading.
>Tim Lee
The problem is being sure of the true edge you have in the *specific*
trade you're about to take. Plans that vary trade size can be very
effective *if* you know the true odds. It's easy to fool yourself.
You can print out a system's statistics and assume that each trade has
the same odds, but do they really? Maybe later you discover a valid
filter that deletes a whole class of unprofitable trades previously
thought to have an edge.
You can calculate performance statistics based on anything you want,
time of day, day of week, moving averages, complex inputs, but they
may be useless for predicting future statistics (which is what odds
are all about). It only works if your inputs are really associated
with some price action. The only proof is that it keeps working in
real-time. If it does, you can act as if you know the odds.
The optimal trade size depends on more than the percent edge. One trade
may have an 80% chance of making a small profit while another has a 30%
chance of a big profit. If you know the true odds, there is an ideal
size for each trade, according to whether you want (1) the best chance
of making the most money possible over time, or (2) the least chance of
failing, or (3) someplace inbetween.
Compare to horse racing, you can win on horses whose true chances are
1 in 20 as well as with those with a 1 in 2 chance, as long as you get
better odds in both cases. The percent edge may be exactly the same,
with equal profit expectations over the next 100 races making flat bets,
but you can safely risk more of your capital on the 50% chances
because a long drawdown is much less likely.
You can "package" your trades arbitrarily by defining "win" and "loss"
in some standard fashion, for example, "up 10 points before down 3 = win",
but you run the risk of imposing artificial parameters. There might be
perfectly good setups that work for 5 points consistently, which you
never notice because you're not looking for that. Each setup has it's
own unique limits and manner of unfolding, and you have to take what
it wants to give you. Since this varies, money management can be a
complicated subject.
Wayne Moody
wlm95@xxxxxxxxxx
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