Examples: Fallacies, Part 1: Money Management is Secondary and Not Very Important

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New article Fallacies, Part 1: Money Management is Secondary and Not Very Important has been published:

The first demonstration of testing results of a strategy based on 0.1 lot is becoming a standard de facto in the Forum. Having received "not so bad" from professionals, a beginner sees that "0.1" testing brings rather modest results and decides to introduce an aggressive money management thinking that positive mathematic expectation automatically provides positive results. Let's see what results can be achieved. Together with that we will try to construct several artificial balance graphs that are very instructive.

Author: Sceptic Philozoff

 

Excellent article, excellent analysis, and excellent topic. I would just like to add a few considerations. Firstly, in the real world money managment is a function of investor risk tolerance and financial goals. I would like to start with an example of this being the constraints placed on managers of Mutual Funds where outside invesments are soliciated. By Law, all such funds must be diversified, must have only a specific number of placements at specific percentages. All of this is for the purpose of reducing risk.

The end point of this is that money managment defined in the terms of any real investment practices is a function of the goals and risk tolerance of the user. Here where the goal is to create a trading system that will perform the best with the least amount of drawdown we are not actually dealing with the real issues involved when it comes to making an EA a viable part of your strategy in an investment portfolio.

So, I would suggest that any form of analysis of EA performace should be constructed on three separate formats. One would be based on conservative low risk constructs of your EA, the second on maximizing the performance of your EA and third on a livable high risk performance. At the core of these points is the question of if you are designing your money managment system to simply optimize performance or are you designing it to produce a generally acceptable rate of return as a serious investment tool. And in the financial world that measure is simply the percentage of return you make in a specific period of time.

Second suggestion. In all of the EA's I have looked at, not one of them has an Input for Draw Down Limit. They will all continue to trade whether you select .1 lot or a percent of margin until there is nothing left in your account. How hard would it be to Input a figure that would stop the EA from trading if it draws down your equity below a certain point? For example, if I have $1000 in my account I could set a Draw Down limit of $800. If my equity goes below that amount then the EA will stop trading. If you should say that there has to be that much of a draw down for your EA to work then consider including an incremental lot strategy that would choose a number that would not tax your $200 limit in the first few trades.

 

In addition, in theory, your management of the number of lots to trade should be a function of the win loss performance of the EA. I would suggest that when anayizing this aspect of your EA preformance you should look closely at the visual performance charts. What you should see is particular situations where your EA performs and particular situations were it doesn't. This is usually in regards to the way the market is moving at various times. I would suggest that if you can identify these situations you could manage your lot sizes according to the performance and non performance time frames. Minimize your investment in the bad times and maximize it in the good times. This is also a part of real world financial managment.

 

Good Trading to Everyone.

 

Fine Stuff, really a big big work...

Ok QBTrader, i agree with some of your underlinings.

I'd just like to point out that, Forex trading involves particular risk measurement approach, the most obvious or frequent one leading to logic gap...

Lets start with the fact that the more lot size you take, lets say agressive MM, the more equity you protect from loss ! Then appetite for leverage should also be seen as risk-adverse characteristic of a trade decision. THink twice,..., Ok lets go on !

 

Once in the process, engaged in a trade, you're exposed to two main kind of risk : adverse spot deviation (ex : long in a bear market) and cash (freemargin) cushion.

The second will not save you long from the first, if you're on the wrong side, you'll loose at least. We should just consider cash cushion as equity fraction you should not put in the trade as spot trajectories shows to be chaotic even when sticking to your target path.

Then, when considering efficiency of an agressive MM, one should measure percentage of losses incured by reduced cash cushion (like stopout), to be treated appart from thoses arising from bad signals entries.

Your ruin probability when trading with big lots (agressive MM) rise with poor cash cushion adjustment, less because of big leverage policy.

Just think of odd/even given probabilities game, and compare the results of two betting strategies. You should know the Casino Martingale Nightmare, dougling your bet after each loss...

The only way for the establisment to vanish out its ruin probability, is to set a max on bet values...if not, the ruin probability climbs quickly to one each time the player loose and can bet once again.

 

Then asymptotically true, the most important loss factor of a trader lies in its risk exposure limits....the one intented to protect him from ruin...Think about it Once Again.....Ok !

At least, soon or later, you win and loose, then the survival factor is the amount you won. Except particular case of a 99/1 (good/bad) system, trade is profitable when gains exceed losses, even if your system is a poor 40/60 (good/bad). How can this be ?

Optimal Cash cushion size in pips, owing to leverage value of your position, results from arbitraging contemporain spot volatility dynamics when entering market. No more, no Less.

 

Great Article

++BuT .....


Optimal Cash cushion size in pips, owing to leverage value of your position, results from arbitraging contemporain spot volatility dynamics when entering market. No more, no Less.


Can you explain this to me please

 

You know I find it kind of interesting that every where you go the people who play this market or that market will tell you that their market is different. They will say in Forex we have these unique problems. You talk to the Index traders and they will say they have a unique situation. The commodity guys are the same. I have traded all of them and the charts all look the same to me and the leverage conditions are virtually identical. So, maybe someone should write an article on analysis of what if any differences there are in different markets.

 

Now I am going to share an interesting story from my experience with the man who invented the Williams %R. Enjoy. It so happens that I signed up for one of Bill Williams training courses not long after he won the commondies trading championship. Bill by the way is a totally great guy.

 
He had come up with a book and all the usual instruction stuff including his indicator which is as he put it supposed to measure the institutional involvment (big players) in the market. It all made perfect sense of course (although I never saw any direct correlation between volume and price. )
 
So, anyway he was one of the first to have a "trading room" where you could trade along with him. As I recall you could do it via conference call or with Yahoo messenger (just came out at the time). On a typical day he would start about by telling us how his indicator showed that we should take this position or that. But, I remember one day in particular when we started out going short on Corn. Not 15 or 20 min later there was an urgent message "Exit the short and go long I recognize this pattern."
 
As the instruction continued this kind of message would come across the wire time and time again where he would throw out all the indicators and take positions based on pattern recognition. To top things off for that month his over all performance was break even at best.
 
I don't know if someone finally pressed him on the issue of how he did so well at the contest but couldn't do any better than anyone else in the real world nor did he actually trade any differently than anyone else but at some point he published an article with the "truth".
 
The "truth" was that he just got lucky!!! The market just happened to be in a recognizable long term trend on virtually every commodity during the period of the contest. No one lost in the market at the time. He admitted that the only reason he won is that he placed positions at the limit of his margin on every trade. Something he would never do in real life - the strategy was all or nothing.
 
So, here is the man who invented the Williams R and actually ends up admitting that it really wasn't worth a damn. But, the legend survives and people use it as if it was the ultimate answer.
 
Good Trading,
 
QBTrader:

Now I am going to share an interesting story from my experience with the man who invented the Williams %R. Enjoy. It so happens that I signed up for one of Bill Williams training courses not long after he won the commondies trading championship. Bill by the way is a totally great guy.

Thank you, QBTrader. Are you really sure Bill Williams (not Larry) has invented %R?
 

I stand corrected. It's been about 20 years now and my memory isn't what it used to be. Here is the guy if anyone wants to know more about him.

http://books.global-investor.com/pages/gurus.htm?PerIndex=1942

 

I guess I should add that I have absolutely nothing agains "Larry". And after that time he became much less analytical about the market and more intuative. He knows his stuff there is no doubt about that. And I would highly recomment his courses if anyone is interested.

I just happened to be there at a time when he was developing his course and riding on his success of the championship. I think he made the adjustments he needed to and as I said he is a caring and simply great individual.

 

看不懂

 
QBTrader:

Excellent article, excellent analysis, and excellent topic. I would just like to add a few considerations. Firstly, in the real world money managment is a function of investor risk tolerance and financial goals. I would like to start with an example of this being the constraints placed on managers of Mutual Funds where outside invesments are soliciated. By Law, all such funds must be diversified, must have only a specific number of placements at specific percentages. All of this is for the purpose of reducing risk.

.....

Minimizing drawdown can be achieved by maximizing leverage...i've talked about logic Gaps...you can only loose your free margin, not the margin value during a trade.

Minimizing drawdown can be achived by implementing cows like risk tolerance limits like institutionnals stringent enforcements you're talking about...think twice : what you're making propaganda with implies that the real exposition to risk is known thus legal enforcements adress adequate institution risk exposure, not what a limited brain financial lawyer group came out with. I really know what i'm talking about, if you want to discuss more about i'll tell what's inside Basel Banks Regulation Act, Sarbanne Oaxley Accounting Reform, Credit Risk and Derivatives Models and Laws Regulation and much more. In fact financial regulation acts on systemic risk failure aversion, enfoorcing to procluding mechanism at least exerting bad risk taking incentives much the time. So Institutions Risk Limits Framework does not provide a sound risk measurement procedures to the forex free trader...

I know all the stuff you're about, portolio optimization methods, Spot/forward hedging, Volatility Terms Structures Curves, Fixed Income Portfolios Management, Banks Asset and Liabilities Financial Risk Management principles, Cristallization, Immunisation and so on...believe me all this does not adress what you're dealing with in Forex wich is straightforward : buy or Sell, at big leverage, leverage being responsible only of the speed at wich you gain or loose, but not of the fact that you're trading a poor signal...

Looking forward :) !

 
MM is a must in any EA. It's included in our expert advisor builder. You get some money management features with just one click. Read more at molanis.com
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