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market to equity ratio
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market to equity ratio

  #1 (permalink)
Amarillo Texas/USA
 
 
Posts: 63 since Dec 2014

market to equity ratio

I think that this is probably the most important question one can ask at the onset of a trading career. I am wrestling with this concept as well.

What I find bothersome as the margin to equity ratio information on the web is the lack of depth on the topic. I see some throwing out of percentages as to what degree of risk is involved but not much else.

Correct me if I am wrong here as I am just figuring this out.
If you are trading crude oil, for arguments sake, say a contract of crude oil requires an initial margin of 5,000, oil is trading at 50 dollars a barrel, and your equity - your account size is 50,000. if you buy only one contract of crude your MTE ratio would be 10%. 5000/50000 = 10%. So in essence you are buying one contract of crude oil at the full notional value of 50,000. You might as well tell yourself you are buying one full contract for the entire notional value of 50,000 and leave out the entire notion of the initial margin of 5000 altogether. This would be essentially no leverage at all, again, correct me if I am wrong. So, as to this example, 10% MTE means no leverage whatsoever. The advantage to this is the one could hold a long position for as long as they want to no matter how great the paper losses are with no risk whatsoever of a margin call. However, one could not do this with a short position.

Now, with an MTE of twenty percent, if you bring this to the notional value level. You are in essence buying two contracts of crude oil for 25,000 each.

Being that one makes one thousand dollars for every dollar that crude oil moves, for a one dollar move.
At 10% MTE you would make one thousand dollars with your capital of 50,000.
At 20% MTE you would make two thousand dollars.

However, I think one can be to simplistic with strictly relying on a percentage MTE. And perhaps. one should be flexible with the MTE depending on the trade you are conducting.
For one recent example, when crude oil was trading down to 26, if you want to trade at a 10% MTE ratio. Let's say that you are convinced that oil will never go below 12, and you expect longer term for oil to go back up to 50. On your assumption that oil will never go below 12, consider that to be the floor.
So Oil at 26. you feel that oil will not go below 12. You can effectively, with your reasoning trade with a 10% MTE, oil 26-12= 14. So, the implied safe notional value would be 14,000 per contract versus 26,000 per contract based on your market assumptions as to the floor that oil will not go below.
Now to continue with the reasoning of trading with a 10% MTE. You are effectively trading at the full contract notional value. You are, in effect, able to trade a future at full notional value just like a stock. Which one would think would render trading an ETF rather stupid compared to trading the future directly itself with a 10% MTE.

This is seriously a topic that should be taken up for a study by a graduate student in finance or economics.
Other factors that I think might be of importance effecting one's application of an MTE.
would be:
1. Your stop loss, 12 tick stop loss? 3 dollar stop loss?
2. Your win/ loss rate. Take your win loss rate and make that applicable to your MTE.

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