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Please review my money management...
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Please review my money management...

  #1 (permalink)
 Vendor: www.indicatorx.com 
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Please review my money management...

Hi traders,

I've spent 6 months full time setting up my trading business. Strangely I've spent a lot of that time working on a money mangement system, rather than entry/exit rules - I've just been drawn to this area of the business. Odd?

Thinking about why that may be, I reasoned it may be that I can control risk, but I have no way of controlling profit or loss, although I believe I have a (very slight) positive edge on the trades themselves.

So what's the thread about? Please take a look at my money mangement system and tell me where I can do better. Thanks in advance for any input. And if there are any ideas in here that help you, glad to offer them up. (FYI I trade spot forex 15 minute charts).




So let's go back to basics. What do I want my MMS to help me achieve? (Perhaps in order of priority)
  • Stop me going broke
  • Squeezing every last drop of profit out of periods of good trading performance
  • Help me protect my profits
  • Work in concert with my trading rules
If I trade badly I want to reduce my risk, if I trade well I want to increase it. But I struggled to find a published mechanism that I was comfortable with so I came up with my own system drawing on known concepts:

I track my last 20 trades to establish a performance rank. The rank determines the % of equity I place on my next trade. This is how I calculate the rank:

(2 x win ratio) x payoff ratio = performance ratio
If performance ratio > 1 performance ratio x total returned R
If performance ratio < 1 performance ratio / total returned R

It may look complicated but once you know what the terms represent it will make sense.

The win ratio is the number of winners divided by total trades. If this was 60% then the figure would be 0.6. This is doubled to give a number greater than 1 where accuracy is better than 50%.

Payoff ratio is average $ winner divided by average $ loser. Where you make more money on your winners than you lose on your losers you will have a figure greater than 1.

Then multiply the two figues together to give your performance ratio. Again, drawing on how often you are right and how much money you make when you are right you have will have a figure greater than 1 if you are profitable and less than 1 if not.

The last part of the calculation uses a return / risk figure, so you will need to know your dollar risk for each trade in the 20 trade sample. Once you know that and what you made or lost on a trade you will have the 'R' figure. Simply put if I risked $100 and made $200 on a trade that trade would be 2R , if I lost $200 -2R.

Add up the 'R' for each of the last 20 trades and if you have a positive peformance ratio (greater than 1) multiple the two figures, and if you have a negative performance ratio (less than 1) divide by total R by your perfomance ratio.

This, I hope, provides a way to track performance. In itself handy, but to of any real use you then need to compare the ranking to a scale to determine your risk. I use this one, but you can use whatever you wish to:

Score less than -10, demo trading (boo hoo, but at least I can't lose any money until my performance improves!)
Score -9 to 0, 0.5% of free equity per trade (OK I'm not performing great across 20 trades but I'm not far off)
Score 1 to 9, 1.5% of free equity per trade (I performing so let's get some decent money on the table)
Score 10 to 24, 2.0%
Score 25 to 49, 2.5%
Score 50+, 3.0%

Sure my 'scale' is conservative but then I am a rooky and I do have the benefit of not having to rush things.

As I said any feedback would be gratefully received. I've built this into a spreadsheet which is easy to update on a per trade basis. Happy to share if any one wants the template. Next step is to perhaps use a more granular % risk figure rather than the .0.5% steps.

Other features of my MMS - read on If you have the stamina!

1. I trade down to microlot level, the added granularity ensures I match % with actual money as closely as possible.

2. I also have some circuit breakers which stop me over trading, revenge trading etc. (I've learn't that tomorrow there will be a whole heap of new opportunities and the market doesn't care if I do domething else):

- 3 losing trades in a row or losses of $XXX stop trading for the day
- 3 losing days in a row or lossess of $XXX stop trading for the week
- Over $XXX profit in a day stop trading
- Over $XXX profit in a week stop trading
- Over $XXX profit in a month stop trading
- If I suffer a 10% drawdown or 7 losing trades in a row I reduce risk to 0.5% (if it is higher than that at that point)
- At 20% drawdown or 25 trades producing a net loss revert to demo trading (if not doing so at that point). And then return 2 sets of 7 trades with a net profit on each to revert to live trading.

3. I have no more than 4 trades open at any time (unlikely due to correlation rules)

4. No more than 3 times the current risk % at risk at any one time (any trade with a stop past breakeven not included).

5. Capital allocation. At the end of each month I add or withdraw money to/from the trading account. I add if I've made a profit in the month, the same amount that I made. Withdraw in a losing month in the same manner.

6. At 35% drawdown I stop trading and get a job.


Thanks for reading.

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  #3 (permalink)
Fortitudo et Honor
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My only advice is that too many traders fall into the pit of worrying about win ratios.

Win ratios are in my opinion, irrelevant....they are a secondary calculation that's subservant to average win/average loss.

Take for example.....a performance report that wins 80% of the time, and has a net average win/net average loss of 1:3.

That means for every 10 trades, you win 8 (at profit of 1) for 8. And you lose 2 for a loss of 6. For a net of 2.

Compare this to a strategy that wins 30% of the time with a ratio of 3:1. It wins 3 out of 10 (at a profit of 3) for a gain of 9 and loses 7 out of 10 (for a loss of 7) for a net of 2.

Which strategy do you think is better? The answer is the second strategy. Because it's much less sensitive to a "bad patch." For the high win%, low yield per trade strategies, it only takes a couple of losers in a row to ruin your day/week/year.

The two biggest commonalities of winning traders is a profit/loss ratio (per trade) of 2:1 or better and adequate capitalization.

MANY winning strategies feature a win rate less than 50%. It seems counterintuitive, but it signifies that when you win, you win big. When you lose, you lose small.

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  #4 (permalink)
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RM99,

Thanks for your replies. And yes I agree with what you say. My system is accurate approx 35% of the time, it's (sort of) trend following so I expect the losers, but attempt to keep a tight rein on them. My stops are ATR based so lower volatility set-ups help a great deal when it's a winner and it rides out.

Thanks for the point you make about accuracy rates and effect on overall returns, that is a point I had not completely considered.

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  #5 (permalink)
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RM99 View Post
My only advice is that too many traders fall into the pit of worrying about win ratios.

Win ratios are in my opinion, irrelevant....they are a secondary calculation that's subservant to average win/average loss.

On the other hand I don't know why so many traders seem to need to think in terms of this OR that as opposed to this AND that.

Expectation of a trade = (PW * AW) - (PL * AL)
Expectation of profit factor = (PW * AW) / (PL * AL)
where
PW = probability of a winning trade
AW = average size of winning trade
PL = probability of a loss
AL = average size of a loss

mokodo, I didn't digest all that enough to really comment but I would test things out to make sure you are not taking off too much risk during drawdowns that you are making sure you don't dig a deep hole but tire your legs out to a degree that it makes it harder to climb out than need be.

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  #6 (permalink)
Elite Member
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mokodo have you tested how making those adjustments affect the probabilities of your overall system? You are on the right track in being concerned about money management. It is very important but you have to understand how all your risk adjustments etc affect your probabilities. You can move a stop tighter thinking it minimizes your risk. But does it? It may on that particular trade but over a string of trades that stop might keep you from hitting targets and you get stopped out 5 times in a row where if it was wider you would have hit target 5 times in a row.

In my opinion you don't want to over complicate your system. The more complicated it becomes the harder it is to consistently measure over what you did last time. The key is to measure everything. To do this though you have to have something that happens consistently that can be measured and compared apples to apples to what you did before. It is the only way you can trade with probabilities. I have tried to develop systems where my stops and targets changed dynamically based on average of previous 5 trades or 20 trades. Problem is I could never get it to work and it was really hard to measure because market is always changing. I am not saying it can't be done this way but I found any consistency hard to pin down. It seemed to add to much randomness to what I was doing. I am not sure if this is what you are doing you may just be talking about scaling your number of contracts. If you are looking at scaling contracts there are many tried and true systems for doing this that you might research.

When you say your system is accurate 35% of the time. Do you mean it wins 35% of the time? If so I would reevaluate the system. That could be profitable but your wins would have to be much much bigger than your losses with very tight stops and very large targets. I am not saying that can't make profit but is going to be tough to maintain over time. I personally would not trade a system with a 35% win rate. rm99 makes a good point that at times to much emphasis is put on win ratios and that a system under 50% can profit which is very true. Win ratios don't always tell the whole story as a system could win 70% of the time and have low targets and wide stops that cause it to lose money. I agree with his comments but 35% is getting fairly low at least for my tastes.

My only suggestions would be

1. Don't over complicate.
2. Make sure you can measure the probabilities apples to apples of your overall system.
3. Be consistent in everything you do.
4. Evaluate your system see if can tweak for a much higher win rate if it is only 35%
5. If looking to scale contracts research one of the many proven systems that already exist. There are times to reinvent the wheel but you might find you don't need to.

"The day I became a winning trader was the day it became boring. Daily losses no longer bother me and daily wins no longer excited me. Took years of pain and busting a few accounts before finally got my mind right. I survived the darkness within and now just chillax and let my black box do the work."

Last edited by liquidcci; June 29th, 2011 at 11:17 AM.
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  #7 (permalink)
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liquidcci View Post
You can move a stop tighter thinking it minimizes your risk. But does it?

Hi Liquidcci,

Thanks for the feedback. I don't refer to stop size at all, this is just a device to assess my performance and tune risk level to current performance.

But point taken on 'keeping it simple'. Whilst there a few things going on to generate the ranking, it only takes a copy and paste of one line of data to an excel file to do the maths.

Let's be clear here, if I was posting a better P&L I would not have the need to be soooo careful about money management. But I think this approach is forcing me to improve my trading skills. If I trade poorly I can not make any money because the system will not let me have money to trade with. As my goal is trading for income full time, this certainly keeps my focus on identifying the areas to improve on.

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  #8 (permalink)
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mokodo View Post
Hi Liquidcci,

Thanks for the feedback. I don't refer to stop size at all, this is just a device to assess my performance and tune risk level to current performance.

But point taken on 'keeping it simple'. Whilst there a few things going on to generate the ranking, it only takes a copy and paste of one line of data to an excel file to do the maths.

Let's be clear here, if I was posting a better P&L I would not have the need to be soooo careful about money management. But I think this approach is forcing me to improve my trading skills. If I trade poorly I can not make any money because the system will not let me have money to trade with. As my goal is trading for income full time, this certainly keeps my focus on identifying the areas to improve on.

Thanks for the clarification.

If you are looking for something to help manage scale. I suggest looking at this program

Money management software :: Market System Analyzer


It has many different methods for doing this and you can test each one against live trade or backtest data. If you have a system you really need to test it to make sure it actually works. This does not reinvent the wheel but allows you to tweak it. Has been worth money I spent on it many times over.

"The day I became a winning trader was the day it became boring. Daily losses no longer bother me and daily wins no longer excited me. Took years of pain and busting a few accounts before finally got my mind right. I survived the darkness within and now just chillax and let my black box do the work."
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  #9 (permalink)
 Vendor: www.indicatorx.com 
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Hi Liquidcci,

Thanks for the link, have run through the videos and product looks excellent.

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  #10 (permalink)
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mokodo View Post
Hi Liquidcci,

Thanks for the link, have run through the videos and product looks excellent.

Sure thing. I would not scale at all until you have gone through the learning process and really developed a system that works. I am an advocate of SIM to start but at some point you have to go live. Live adds the a whole different element to the game. SIM is like watching videos of riding a bike. You can learn much but at some point you have to get on the bike and probably will get some bruises. But getting bruised is only way to learn.

I would suggest SIM first then live at some point but stay with 1 contract. Absolutely do not scale until you get experienced and learn how to use probabilities among other things. This is the roughest business environment in the world and there is no easy path to learning it. Best you can do is try to protect yourself while learning it which looks like what you are trying to do.

"The day I became a winning trader was the day it became boring. Daily losses no longer bother me and daily wins no longer excited me. Took years of pain and busting a few accounts before finally got my mind right. I survived the darkness within and now just chillax and let my black box do the work."

Last edited by liquidcci; June 29th, 2011 at 02:14 PM.
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