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> I tend to agree, but I wouldn't conclude that risking 10%
> necessarily translates into a near-certain risk of ruin. Risk of ruin is
> affected by the characteristics of your system, the markets you trade and
> the largest loss you will suffer.
I agree except I would make that the biggest STRING of losses you will
suffer. I haven't read Vince's books so correct me if I'm wrong but that
seems to be the big weakness of optimal f. It bases it's calcs on things
like the biggest loser, the average loser and the percentage of losers
but it doesn't consider what would happen if all the losers happened in
a row. So people try to give themselves a safety factor by trading a
some fraction of optimal f but Vince doesn't give you any guidance for
choosing that fraction. So, you might as well just hold your finger up
in the wind and guess. <joke> I've heard optimal-F nicknamed how F-ast
can you go broke. </joke>
> One thing it cannot anticipate is the 3
> Standard Deviation and 4 Standard Deviation losses (unless you have captured
> one in your system testing) that traders are exposed to at some point in
> their lifetime.
Yup. Niederhoffer, LTCM, and the list goes on. IMHO, a Monte Carlo
simulation is the best way to do that. Take your historical trades (100
or more, trading one contract), shuffle them into a random order, and
calculate the max drawdown. Repeat 10,000 or so times and you can get
some interesting stats like 50% chance of $ww drawdown, 10% chance of
$xx drawdown, 1% chance of $yy drawdown and 0.1% chance of $zz drawdown.
Then decide your risk comfort level (aggressive or chicken) and trade
one contract for each $jj in your account.
For example, with my own system, cutting my size in half cuts my risk of
ruin from 10% to 0.1%. Being basically a chicken, that's a trade-off I'm
more than willing to make.
Actually, that's the simple version. To do it right, you need to adjust
your historical trades so each one had an equal dollar risk. Then run
the Monte Carlo and you can come up with a safe percentage of your
account to risk on each trade. Don't know your risk before you enter
each trade? You should. Once you have those numbers, it's a piece of
cake to implement.
> Risk of ruin is certainly something you should calculate
> and be aware of, particularly if your money management system is telling you
> to risk big money.
Risk of ruin is the MOST important thing. That's where it all starts.
Without that, none of the rest of it matters.
--
Dennis
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