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Drawdown & Position Sizing Account Allocation


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Drawdown & Position Sizing Account Allocation

  #1 (permalink)
Atlanta GA
 
 
Posts: 21 since Dec 2010
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Drawdown & Position Sizing Account Allocation

Hello -

What I am trying to understand is both drawdown and position sizing schools of thought. Let's say I have five systems that I am day trading (ES,TF) on a $25K account, keeping the math simple, allocating a hypothetical $5K/system.

For DD testing purposes, should I allocate $5K per system testing drawdown, or allocate the full $25K per system, although each system is not trading near the actual dollar amount due to intra-day margin requirements. If I define my risk of ruin at 35% based on the total AMDD of all systems combined, I should be trading with a $25K account. I'm not understanding what dollar amount or allocation I should use to calculate individual system drawdown.

Similar question to position sizing - if I used a Fixed Ratio method on 5 systems, would I start increasing position size based upon the growth of the hypothetically allocated $5k per system?

Thanks in advance for your thoughts...

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  #3 (permalink)
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Before you talk about drawdown, you need to first identify the risk per trade.

How much are you risking each trade in percentage terms of your total account size?

For example, if you are setting a stop loss at $500 and your account size is $50,000 that is 1%.

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  #4 (permalink)
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Big Mike View Post
Before you talk about drawdown, you need to first identify the risk per trade.

How much are you risking each trade in percentage terms of your total account size?

For example, if you are setting a stop loss at $500 and your account size is $50,000 that is 1%.

Mike

The max risk on any trade is $625, in one system. All others are $500 or less.

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  #5 (permalink)
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dgresens View Post
The max risk on any trade is $625, in one system. All others are $500 or less.

OK, so 2.5% of 25,000 account.

But if you put on multiple concurrent positions, you could easily be risking several times that. You'll need to identify any correlation between these trades, and if they are correlated then I would suggest trading fewer shares or micro size lot to reduce position size so the total risk across all positions is less than 5%. If they are not correlated then this isn't as important, but there will still be strings of volatility where you will see correlation and large drawdowns.

I am not aware of a formula to calculate drawdown. Instead, it is based on historical results which you would gather through extensive forward testing of live market, simulated trades. The larger the sample size the better. I would not pay much attention to a backtest, only to a forward test.

Whatever the analysis shows, I would still increase it because there are always unknown events, fat tails, black swans, etc.

If you are ultimately asking when to know if a system stops working, then again it would be a comparison of two groups of trades --- first group is your large sample size of forward tested trades before you went live, and second group is the actual cash trading results. Measure on things like MAE, MFE, average win, average loss, win percentage, trade expectancy, etc. If these columns start to strongly deviate from one group to another, then either one of the groups has inadequate sample size, or the markets have changed and your method is no longer working.

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  #6 (permalink)
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dgresens View Post
Hello -

What I am trying to understand is both drawdown and position sizing schools of thought. Let's say I have five systems that I am day trading (ES,TF) on a $25K account, keeping the math simple, allocating a hypothetical $5K/system.

For DD testing purposes, should I allocate $5K per system testing drawdown, or allocate the full $25K per system, although each system is not trading near the actual dollar amount due to intra-day margin requirements. If I define my risk of ruin at 35% based on the total AMDD of all systems combined, I should be trading with a $25K account. I'm not understanding what dollar amount or allocation I should use to calculate individual system drawdown.

Similar question to position sizing - if I used a Fixed Ratio method on 5 systems, would I start increasing position size based upon the growth of the hypothetically allocated $5k per system?

Thanks in advance for your thoughts...

I would backtest each system integrating fixed ratio into the backtest. Starting with 5k may be enough to start with or it may not be. Also your delta under fixed ratio (when to increase or decrease) can only be accurately determined with extensive testing. It is really important to integrate your money management into backtesting and see how it effects things. Otherwise you could end up taking on to much risk or possibly leave to much profit on table by taking to little.

One way to approach would be to start with one system at 5k but keeping your 20k in reserve. Then when that system makes 5k instead of increasing contract size open new system with the 5 k you just made. Keep doing this until you have 5 systems running. Once have 5 running then apply fixed ratio to all systems and start to increase contract sizes based on delta your backtest etc produced. Of course 5k may not be the magic number. That would also need to be determined through testing.

This way you grow into your systems and keep a good reserve in place as you do it.

Just food for thought

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  #7 (permalink)
Atlanta GA
 
 
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liquidcci View Post
I would backtest each system integrating fixed ratio into the backtest. Starting with 5k may be enough to start with or it may not be. Also your delta under fixed ratio (when to increase or decrease) can only be accurately determined with extensive testing. It is really important to integrate your money management into backtesting and see how it effects things. Otherwise you could end up taking on to much risk or possibly leave to much profit on table by taking to little.

One way to approach would be to start with one system at 5k but keeping your 20k in reserve. Then when that system makes 5k instead of increasing contract size open new system with the 5 k you just made. Keep doing this until you have 5 systems running. Once have 5 running then apply fixed ratio to all systems and start to increase contract sizes based on delta your backtest etc produced. of course 5k may not be the magic number that would also need to be determined through testing.

This way you grow into your systems and keep a good reserve in place as you do it.

Just food for thought

That's excellent advice and I appreciate it liquidcci - Thank You.

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  #8 (permalink)
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dgresens View Post
That's excellent advice and I appreciate it liquidcci - Thank You.

Sure thing. Also I would expect each system may have different capital requirements and fixed ratio deltas. I like to treat each signal I have as a different system because each one has it's own characteristics.

"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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