rhuz 

@Fat Tails I got curious about what you said on adding or taking into account the risk of ruin. Obviously newbie here, could you explain this a little bit further or point me into something where i can learn more from risk please?. Thanks in advance. Rhuz.

There is an entire thread on the subject of "risk of ruin" here:

Risk of Ruin I'd like to start a discussion on Risk of Ruin. The general concept of a Risk of Ruin analysis is to determine if you will go bust over a statistical number of trades. For example you may have a probability edge of 65% but after factoring commissions, …

kevinkdog 

Correct me if I am wrong, but this is the money management technique put forth by Ryan Jones in his book "The Trading Game." This approach works wonders when winning trades are made, but can be disastrous when a drawdown is hit (which can be said for most money management approaches). The book author used this approach to do great in a trading contest, tripling his money in 3 months (or something like that), but a few months later he had blown out his account with the fixed ratio technique. I don't doubt OP's success with the method, but it may not be appropriate for everyone...

I realize this is an old thread, but it is an important topic that deserves the bump.

Kevin, I think fixed ratio is a brilliant money management technique for small accounts. At the start it focuses on preservation of capital, then, as the account grows, the leverage increases dramatically. Yet, with further growth, when the account allows for trading around 15 contracts, the exposure is not different from fixed fractional, i.e. risking n% of the account on every trade. There is more. With fixed ratio the rate of decrease in the number of contracts is higher than the rate of increase. For example, if in order to get from 5 to 6 contracts your account needs to increase from (hypothetically speaking) 80k to 100k and you are currently trading 6 contracts, when the system hits the drawdown you go back to 5 contracts when the account decreases to 90k, thus reducing the exposure and helping to preserve the capital.

Based on my personal experience I suspect Ryan Jones blew his account not because of fixed ratio, but because he violated it. In the past I had great success with FR twice. I will be honest, I gave most of it back when the system hit a drawdown. However... I gave it back precisely because I started violating money management template. In short, I built up my account to trading 10 contracts of ALSI futures (South African index) and then decided to do something that seemed very smart at the time (I admit, becoming the King of the Universe was one of my trading goals). Instead of continuing to add contracts as per template I decided to treat 10 contracts as "a unit", so now my account would grow in multiples of 10 contracts. In retrospect the outcome was predictable, though I had enough discipline to stop doing stupid shit when my account returned to the original amount.

Fixed Ratio is also useful for portfolio allocation. I've seen a few of trading bloggers who allocate the same amount of capital to the system or instrument, without consideration of its current performance. To me it doesn't make sense. What makes sense is to put more money into a system that is currently hitting a winning streak, and less into one that is currently in a drawdown. You can do it with any money management, but fixed fractional will produce way better growth than fixed fractional. You can argue that Kelly formula is even better, but the problem with it is that it doesn't focus on capital preservation at the beginning.

I think fixed ratio is as close to the Holy Grail as it gets. Currently I am figuring out how to use it with Forex CFDs - the size is much more scalable than with futures or stocks, and so the jumps in size and the corresponding leverage doesn't have to be too dramatic.

In regards to the risk of ruin. I think of all testing stats this is the least useful. In the long run you eventually get enough monkeys with typewriters, so to speak, to make sure every one of your position goes against you. Courtesy LTCM, the best and the brightest.

ursus 

Based on my personal experience I suspect Ryan Jones blew his account not because of fixed ratio, but because he violated it.

I can only tell you what the actual broker involved with the account told me. Not sure how your personal experience changes what the broker witnessed, but I wish you luck with fixed ratio.

kevinkdog 

I can only tell you what the actual broker involved with the account told me. Not sure how your personal experience changes what the broker witnessed, but I wish you luck with fixed ratio.

Did the broker tell you any details, such as number of contracts and corresponding capital? I am just curious how it happened, given the math of the method.

ursus 

Did the broker tell you any details, such as number of contracts and corresponding capital? I am just curious how it happened, given the math of the method.

Yes, enough details were provided that I felt the conversation was true.

kevinkdog 

Yes, enough details were provided that I felt the conversation was true.

Well, I know of several cases where traders blew their account using fixed fractional, risking 1% of their equity per trade. So I am guessing no method can protect you.

ursus 

Well, I know of several cases where traders blew their account using fixed fractional, risking 1% of their equity per trade. So I am guessing no method can protect you.

100% agree! I'll bet those 1%s at some point abandoned what they were doing, because if they rigidly stuck to 1%, it is pretty tough to blow their account to $0 (it would be possible to bring account down to a level where there was not enough money to initiate a trade, which in my book would be a blow up).

I think position sizing can make a huge difference in results. I think Ralph Vince, inventor of Optimal f, says position sizing accounts for 70% of variation in returns.

The problem that I have seen is most people look at their backtest, apply 10 different ps methods, and pick the "best" one. They use that going forward, and guess what? It usually fails. Why? Because it was optimized!

Most people don't realize that ps can be optimized.

kevinkdog 

I'll bet those 1%s at some point abandoned what they were doing, because if they rigidly stuck to 1%, it is pretty tough to blow their account to $0

Kevin, you may not notice, but are mirroring my point. For me it seems as unlikely that Ryan Jones blew his account sticking to FR as for you losing everything while risking 1% of equity. I am sure he went berserk when the system went into the drawdown and started doubling up trying to "make it back on one trade". I have done it before, and that's what I meant when I mentioned my experience. Fixed Ratio money management is structured in a way that you can stick to a minimal risk when you trade 1 contract (1 forex lot, micro lot, 100 shares etc.), such as 1 - 2% of equity, which, with reasonable capitalization, makes the risk of ruin unlikely. So if Ryan Jones tripled his equity in three months and then hit a drawdown that brought him back to his original capital he should have gone back to trading, according to the method, 1 contract. If he blew his account he either violated the rules of position sizing or the system fell apart and he traded his account into the ground to sticking to a losing algo.

I is obviously important for the trading system to have positive expectancy. After that position sizing is crucial. Diversification is also important, but it is not a promise of salvation either. For me the only solution against ruin is taking money out of the market on regular basis and putting it somewhere else.

In regards to optimization, I agree, many of us fall victims of seduction by the best test.

ursus 

Kevin, you may not notice, but are mirroring my point. For me it seems as unlikely that Ryan Jones blew his account sticking to FR as for you losing everything while risking 1% of equity. I am sure he went berserk when the system went into the drawdown and started doubling up trying to "make it back on one trade". I have done it before, and that's what I meant when I mentioned my experience. Fixed Ratio money management is structured in a way that you can stick to a minimal risk when you trade 1 contract (1 forex lot, micro lot, 100 shares etc.), such as 1 - 2% of equity, which, with reasonable capitalization, makes the risk of ruin unlikely. So if Ryan Jones tripled his equity in three months and then hit a drawdown that brought him back to his original capital he should have gone back to trading, according to the method, 1 contract. If he blew his account he either violated the rules of position sizing or the system fell apart and he traded his account into the ground to sticking to a losing algo. I is obviously important for the trading system to have positive expectancy. After that position sizing is crucial. Diversification is also important, but it is not a promise of salvation either. For me the only solution against ruin is taking money out of the market on regular basis and putting it somewhere else. In regards to optimization, I agree, many of us fall victims of seduction by the best test.

Of course I realized that, I know you want to believe that fixed ratio was not to blame. My info says it was not, maybe I was lied to.

Kevin, I gave you my reasons why I find it hard to believe FR was the reason for the account blow up. The best you can come up with is "that guy told me". So be it.

Refer to my avatar.