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Russ:
Following are just my opinions, some are sure to differ...
An entry strategy cannot have ANY "accuracy" without some form of exit
method, so "55% best case" is meaningless. One approach would be to
assess "is the position profitable including costs after N bars?".
But care has to be taken even here; what if the price moved below where
you would have put a stop during the course of those N bars? And of
course such an exit strategy may be meaningless to how you are really
going to trade...so you have to really assess it based on your complete
trading set of rules.
Ergo, it's "impossible" to assess any subcomponent of a trading method in
isolation. At best, we can get some characterizations and comparisons of
them based on simplifying (and hence error prone) assumptions.
I like to base position sizing on several key things:
1. Overall profitability and consistency of the trading method. If
it's a negative expectation system, no question, the best position
size is zero! If the winning trade percentage is low, well I don't
like that much either, for the simple reason that such system rarely
compound well (can grow equity sizes quickly/consistently in an
exponential way). And if the profitability per trade isn't very
high, then it better trade a heck of alot, or else I'm not utilizing
my capital efficiently.
2. Largest loss "probable" (largest possible loss in commodities is
the entire contract value if long, and my entire net worth if short,
that's sobering), combined with my amount of equity I'm allocating
to trade the system. I like to consider risk of ruin figures for
a given fixed position size which I would trade over and over. I
like that risk of ruin to be down in the 1.5-2.5% range. That sets
the position size. As I add or decrease my equity after each trade,
I recompute risk of ruin for different position sizes, and choose
the new position size to keep risk of ruin down in the 1.5-2.5%
range. (Point #1 is critical here!). This system breaks down if
equity gets so small that a minimal lot size (one contract or
I suppose one share) generates too much risk or the margin requirement
exceeds the equity; that's the "undercapitalized" point where it's
time to refinance and/or reconsider!
3. Optimal f. I don't directly use it, but I DO compute it, in order
to determine the "strength" of the system. The higher the optimal
f, the better (all else being equal which it never really is),
because it indicates the system has excellent profitability and
consistency of winnings. Only systems with high optimal f's
really get my attention (0.7 to 0.9 is the range I like). By the
way, computation via a spreadsheet is really quite simple, I can
explain it if you are interested. One caveat: consider using "worst
case reasonable" max loss instead of "worst case ever experienced",
because the worst loss is always the one in the future, not in
the past. This is IMO the biggest flaw in Ralph's optimal f method,
along with a failure to assess risk of ruin in some meaningful
way (for example, for a system I have, he would have me risk 90% of
my equity in a single trade that has a 16% chance of being a
loser (assuming I suffer a maximum loss). Whoa!! I'm NEVER going to
bet like that! Not to mention what happens if I used a maximal
loss based on history, and instead I had the misfortune of suffering
a loss 1.5x that...I'd be having to send another 40% of my starting
equity to my broker to pay off someone!!
-Kevin
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