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I would size the first trade as a fraction of the optimal fraction or
"Optimal F". (Recommend you read Ralph Vince's books). Another possibility
is to set up an account hedged with cash, and trading the risk portion of the
portfolio at the Optimal F. To arbitrarily select a fraction of capital to
risk, is not a good way to trade. If that fraction is beyond the optimal f
for the market/trading system, then you will go broke.
Too far the other way, and you are missing the potential reward for the risk
you are taking.
I personally use fixed ratio, but I'm not about to say that it is superior to
optimal fixed fraction (optimal f). Mathematically, it is not and Ryan
states this. Your statement that the fraction ought to be the same % for
each trade is correct when the trade outcomes are random ie. not correlated.
If they are correlated, then varying trade size (fraction of account equity)
could be the best way to go. That would depend on whether you can devise a
trading system to effectively benefit from the correlated results.
I have personally settled on fixed ratio for more practical reasons. Optimal
F calc's are tedious where fixed ratio calc's are simple. I have set up
simulations (fixed ratio vs. optimal f) in Excel based on my actual trading
statistics ie. (ave % gain, ave% loss,max % loss, % drawdown, # of wins, #of
losses, etc.). Optimal F money management easily beats fixed ratio. But not
necessarily in the beginning. Like Ryan states, there may be an advantage to
using fixed ratio trading initially and then progressing to optimal f. My
simulations have shown this to be likely, but not necessarily so. (ie. more
often than not).
However, Delta in fixed ratio trading can be set to extremely aggressive
trading.
I'm trading one portfolio very aggressively and another portfolio not so
aggressively. Surprise, surprise, the aggressive portfolio has more
variability and more return than the less aggressive portfolio. I haven't
run any Sharpe ratio stats to see if the added return is worth the risk I'm
taking. I suspect that it is.
There are other practical matters to consider, like can you sleep at night.
The money management strategy you use has to consider your ability to deal
with the math. If optimal f is too complicated for you, then it is not an
option.
More importantly, I would guess that most traders have no concept of money
management (ie. a positive expecatation and how to leverage it), and would
benefit greatly from having that knowledge.
Kevin Campbell
In a message dated 2/29/00 1:34:24 PM Central Standard Time, andrew@xxxxxxxxx
writes:
> (I apologize as this is somewhat long ...)
>
> I would like to start a discussion on the merits and weaknesses of the
> Fixed Ratio position sizing method popularized by Ryan Jones.
> Specifically how does it stack up against the other predominant position
> sizing method known as Fixed Fractional.
>
> The majority of the research I have conducted was based upon the fixed
> fractional method, or sizing your position based upon the risk the
> position represents and the percent of your total equity you wish to
> risk.
>
> For Example:
>
> You have a $100,000 account balance and wish to risk 10% of your account
> on each trade, or $10,000.
>
> You have an S&P Trading System which buys on a breakout of the highest
> high of the last 5 bars and sells on a breakout of the lowest low of the
> last 5 bars. You would reverse your position with each occurrence. (I
> am not advocating this system, nor have I tested this, I am only using
> it as an example).
>
> Your first trade has a risk of $2,000 so you would trade 5 contracts
> (10,000 / 2,000 = 5).
>
> Your first trade is a $750 winner so your account balance is now
> $103,750.
>
> Your second trade has a risk of $4,250 (the market has a greater 5 day
> range) and you would trade 2 contracts (103,750 / 4,250 = 2.44 ==> 2).
>
> You would continue this as long as you traded.
>
> The above makes sense logically to me. With the Fixed Ratio Method, I
> see some Problems:
>
> 1. How many contracts do you trade on your first trade? The method
> explains how to change your size once you have begun trading, but I am
> unclear on how to size your very first trade.
>
> 2. All trades are sized the same. Why would you want to risk varying
> amounts of capital? In the above example if you were trading a fixed 4
> contracts per trade, you would assume risk of $8,000 on the first trade
> and a risk of $17,000 on the second. I do not understand why different
> trades should represent differing amounts of risk for your account if
> the outcome of each trade is unknown and as the same probability of
> success or failure.
>
> I hope that this is a good start for an educational discussion amongst
> ourselves regarding what many consider the most crucial aspect of
> successful trading. I am looking forward to following the ensuing
> dialogue.
>
> Best regards,
>
> Andrew Peskin
>
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