This is my first post and I've been reading as much as I can to try and find an answer to this question but I have not had a lot of luck. If I have overlooked a thread discussing this please share the link.
I'm just starting out in trading and I am currently working to develop a money management plan. I read a few posts/web sites regarding the risk of ruin and position sizing and this is the method I've come up with.
1. Determine Optimal f based on historical performance of the trading plan for the specific instrument.
2. Apply Optimal f to risk of ruin formula using a multiple between 1 and .25 of Optimal f so that RoR is reduced to an acceptable level.
3. Never risk more than X% of available capital per trade regardless of the output for #2.
The questions I am trying to figure out are:
1. Is this plan redundant? Why do I need to do #1 if I'm going to override it in #2. My thinking was, I could use RoR to determine the position size but that may not be the optimal size hence the addition of #2 but then do I need #3?
2. Is this plan ignoring a major piece of the position sizing process? It seems too simple.
I would appreciate some feed back from the collective wisdom of the community and perhaps some direction.
#3 is probably going to be your limiting factor, because optimal f (and fractions thereof) typically risk a lot more than a few percent per trade, which is what #3 does. Optimal f maximizes rate of geometric growth, but at the expense of huge drawdowns.
So, IMO you really don't need to calculate optimal f. What you need to do is figure out the value of f that maximizes return, for a given Risk Of Ruin and a given max allowable % risk of capital. You'll have to check that the max drawdown is acceptable.
I am currently running through a real world example of one way I do position sizing at this thread. Unfortunately, I probably won't get to the detail you need for another week or so. But, it may eventually help you out.
If you have any questions please send me a Private Message or use the futures.io "Ask Me Anything" thread
All I can say from my own experience is that I started off with perhaps the most convoluted plan, and it has since become far far simpler. In hindsight I can safely say I was just sh*t scared of losing so thought a plan would protect me from that. It was a way to avoid responsibility.
18 months on I do not have a 'maximising' element in my money management (optimal f and the like). I just use a tiny % of my capital per trade (0.3%) and leave it at that. Optimising issues simply led me to focus on the wrong things. There are some Ernest Chan webinars here on futures.io (formerly BMT) where he goes into the math/theory in detail.
If I had my time again I could have sped up my learning curve by using a very straight forward money management plan straight away and accepted responsibility for all the outcomes - wins and the losses.
I do think focusing on this element before trading reflects a risk-averse character. I believe you have a greater chance of longevity if you start adverse and learn to become risk seeking, rather than the other way around. It will greatly increase you chance of not blowing through capital whilst you build skills and experience. Again, just my experience.
Happy trading to you
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