Trading Account Management Discussion

[TheNegotiator 13]

I thought about calling this thread "Secret Trading System Revealed!" or "Strategy Guaranteed to Make X Return" because I know that for many, the idea of money management in trading holds little interest. I decided against it though because "you can take a horse to water, but you can't make it drink" so to speak. More than anything I hope to get a proper discussion going to highlight the importance of paying proper attention to the figures and trading accordingly and discuss ideas. I hope this thread can be a place where more experienced traders can share their ideas and newer traders can learn and ask questions.

[TheNegotiator 13]

One of the top trading secrets is money management. All traders have heard of it and some may think they actually know it. But how many traders practice sound money management?

 

Most traders lose mony because they lack money management, do not have enough knowledge of the market they trade, do not have a sound trading methodology, and trades a market that does not fit their style.

 

If the average win per trade is greater than the average loss per trade, a 50% winning trading setup can make you money. But excess risk, greed, poor psychology, and the failure to understand probabiltiies can take an account with a 60% winning methodology to ruins.

 

There are several money mangement models. In this thread, Im going to discuss just the basics of account sizing and peek-to-trough drawdown.

 

Alot of new traders fail get into the trading business hoping to make a million by the end of the year with a $5,000 to $10,000 account day trading. This is an unrealistic goal. Day trading is a business of grinding profits everyday. Consistency is the key to survivial and learning to ring the register often. One of the main reasons why new traders go bust is their account size. A $5,000 to $10,000 is too small to practice sound money management. A 10 point YM loss is equivalent to $50 per contract. $50 is 1% for a $5,000 account. 3 losses a day and a trader has just lost 3% of his account. Now 3% may not sound like a big deal but take a look at the data below:

 

 

The percentages really start to change after a 30% drawdwn. A 50% drawdown requires a trader to double up just to break even. A gambler mentality tells a trader to double up his position to make back a loss. This is one of the worst habits a trader can have. Frustration and lack of emotional control will cause a trader to double his size on the next trade in hopes to break even. At first this may work, but it leads to bad habits and will lead to bust.

 

 

Peek-to-trough Drawdowns

 

Let's say you are a fund manager managing other peoples money. Your initial fund size is $500,000. In the first month, you managed to increase the $500,000 to $750,000 for an impressive 50% gain. Now the next month you dont have any good trading signals. However, your portfolio goes down to $600,000 in value. You have not made a single trade that month, however your accout has gone down from $750,000 to $600,000. the peak-to-trough drawdown would be (peak = $750,000 and trough = $600,000) $150,000 or 20%. This has occured without a single losing trade that month.

 

Your clients are only concerned about this 20% drawdown. If they simply withdrew their money the month before, they would of been $150,000 richer. The third month, your $600,000 account goes down to $525,000. Thus the peek-to-trough drawdown is now $225,000 or 30%. From industry standard, your annual rate of return of is 5% (up only $25,000) with a 30% peek-to-trough drawdown. This data will label you as a terrible money manager.

 

In calculating risk vs reward, we need to look at the peek-to-trough percentage. If your annual rate of return is 5% a year with a 30% peek-to-trough drawdown, your risk-to-reward ratio would be 5/30 or 0.166. This is a terrible ratio. Make sure to keep this in mind when day trading. Although at the end of the day you may have been up, what was your drawdown? If you are trading with a $5,000 account and your account goes back and forth from $4,500 to $5,100, are you practicing good money management? Do you have good trading strategies and setups? Is it worth the stress of seeing your account fluctuate to $4,500 just to make $100?

 

I hope this makes sense. Money management is everything in trading. We are in the business of risk. Happy trading

 

I had a quick look at what was on TL already and there seems to be a reasonable amount. If anyone has a particularly useful thread to add, please post it. Anyway, I came up with this one from James, the founder of TL. Pretty useful post really. 12 replies. 12 flippin' replies. I'm not surprised but it does seem somewhat of a shame. But there you go.

[TheNegotiator 13]

So I'll get started with some really, really simple basics just to make it clear that MM and sticking to your risk limits and max daily losses are very important.

 

First simple chart. Following on a little from James' chart, here is effectively a risk of ruin chart:-

 

 

It's assuming a 10k account and no margin for simplicity. The point is that very quickly as a greater original % of the account is risked per day (or per trade), the number of losing days in a row that the account can withstand drops dramatically. This doesn't take into account commissions even, so you can see how important having an appropriately funded account is.

[TheNegotiator 13]

Next, I've just taken a random set assuming a goal of taking 2 points per day on a $10k account. The number of contracts traded is the account balance/$5000 i.e. 2 to begin with. The max daily loss is set to 4 points per contract - so initially on 2 lots a max loss should equal $400. Just for ease, I am talking about ES where 1 point = $50/contract, but it applies to anything. I've randomized the data to get roughly +2 points/contract average per day. On the second column, I've turned 1 -4pt max loss per day to between 6 and 12 points once a month (used 200 traded days for a year and 17 days/month ish) to simulate a loss of control by a trader. I've not accounted for whether a big loss would negatively affect trading on subsequent days or not, neither have I addressed whether the max loss is appropriate- clearly if your max loss is 4 pts but you frequently go over and finish up for the day, you daily loss limit could need to be tweaked. Anyway, this is how an account is affected when trying to build it up over the course of a year:-

 

Edited August 29, 2012 by TheNegotiator

[TheNegotiator 13]

Just to clarify, the difference in number of points per contract over the 200 days is 47 or 12% less. But when you look at the final balance, the difference is substantial. It's $131,650 lower or 39% less because of how many contracts were traded. Now this is in a world much closer to 'perfect' than many would recognize, so you can only imagine how it's a problem for the average trader if it's not looked after properly.

[TheNegotiator 13]

Anyway, like the title of the thread suggests if you want to comment on or ask questions talk about a different aspect of MM then please do so! :helloooo:

[kayaktri 10]

Negotiator,

 

Thank you for posting this subject matter, and reminding all of us how important MM really is. I would like to share a couple of comments that may be of some use to others beginning their education.

 

It is my opinion that ones education on the topic of MM should come first, prior to anything even closely associated with trading setups, etc. My path did not start this way, but I certainly wish that it had. Without MM, you have the very highest possibility that your equity will not last. For example, a good entry system without good MM equals very high probability of a ruined account. Even a good entry and exit system without good MM equals a high chance of a ruined account. Everything else less worthy (from a systems quality perspective) equals a ruined account.

 

How does one take steps to develop a proper MM strategy for themselves? .....Education.

 

There are many threads and posts here on TL that are very helpful in the quest of educating ones self on a proper MM strategy. I found many of them helpful (here and other areas of the public domain). However, I was unable (at the time) to differentiate which opinion being represented was valid or not (one that would hold up to actual long term testing). There are many people on this forum who have quite different ideas on the topic of MM, and not all of them would pass statistical or mathematical study (my attempt at being gracious).

 

I also recommend looking at published works to further educate oneself on this topic. I had my eyes opened a number of years ago to the importance of this matter when I read through some books that I would recommend for anyone who has not delved into this topic. The first book that I read that discusses this topic is 'Way of the Turtle' (Faith). In it the author discussed what Negotiator is stating above, on the possibility of risk of ruin, and the basis for this term.The author discusses several very important concepts in the "Risk and Money Management" Chapter. This should be enough to get your interest up as to the importance of this topic. The next book that I read after this one that was instrumental with my learning the important aspects of MM was "Trade Your Way To Financial Freedom" (Tharp). This was a real eye opener for me at that time, as it instilled in me that I had to have not only a proper MM system (from a statistical probabilities perspective), but one that was a proper MM strategy for me (fits who I am as a person - my psychological profile). This work also allowed me to understand that "my" MM system would dictate a lot of the parameters of what my trading system could look like (and just as important could not look like), based upon my account size and my aversion (or lack of aversion) to risk. One of the more recent books I have read that delves into this topic is "Modeling Trading System Performance" (Bandy). There are multiple examples of MM strategies (and the why's and how's behind them) that one may use on their path of discovery for their proper MM strategy. Lastly, Tharp also has a book called "A definitive Guide to Position Sizing" that remains very helpful in giving one a basis for this topic.

 

My path took me from searching on the public domain to published works. And I now will not do anything that deviates from my MM system (incur more risk). I am convinced that if I do, I cannot achieve any long term success in the markets. In other words, once I setup my level of risk, which is always done prior to entry, I never increase this level of risk (In fact I do not even think about increasing my risk). I would suspect that others may not be in agreement with this, but I would refer anyone interested to look at a study of statistical probabilities and make their own determination on which system is right for them.

 

Best wishes . . .

[4EverMaAT 10]

Anyway, like the title of the thread suggests if you want to comment on or ask questions talk about a different aspect of MM then please do so! :helloooo:

 

Drawdown is just a natural part of trading. Just like an airplane must maintain lift regardless of the altitude height, or a ship must stay afloat regardless of how deep the water. When you get to your destination, the heights and depths that were used to get there are irrelevant. The risk returns to zero when no trades are open;)

 

Trying to use time like a 4 hour or daily loss limit to artificially stop out what you think is or is not an acceptable loss doesn't respect that the market may have its own point of view on how far prices will trend. A much more accurate stop loss would be based on a range of prices, which can be adjusted depending on how many positions you take on. Once you reach your profit target (or stop loss), the drawdown in between didn't matter.

 

Drawdown only matters in terms of knowing the maximum positions you can hold vs amount of available equity, no different that knowing how much gas you need or what your mechanical limits are. I just want to make the clear distinction between determining position limits based on mathematics and overall mechanics of the trading strategy vs fear under the guise of 'preference' or 'risk tolerance'. One is personal, the other is not:cool:

Edited August 31, 2012 by 4EverMaAT

[TheNegotiator 13]

It is my opinion that ones education on the topic of MM should come first, prior to anything even closely associated with trading setups, etc. My path did not start this way, but I certainly wish that it had.

 

I think this is a big thing that new traders fail to address. It's not a big draw for them though. Lots of fancy lines seesawing back and forth on a chart however...

 

It's true that you must have some sort of defined method to trade. I would suggest a framework for describing market state is the best place to start though. But after that it's imperative to understand and employ MM.

 

Drawdown is just a natural part of trading. Just like an airplane must maintain lift regardless of the altitude height, or a ship must stay afloat regardless of how deep the water. When you get to your destination, the heights and depths that were used to get there are irrelevant. The risk returns to zero when no trades are open;)

 

True. This is why it's important to identify risk based on the market and then work out position R:R, size or even if it's worthwhile taking the trade at all. The market doesn't care about your account so you must!

[BlueHorseshoe 10]

I think that possibly one of the reasons that this topic generates so little interest, even from those who do fully appreciate the role of MM in successful trading, is that there's relatively little scope for discussion or development, especially unless one is prepared to get involved in more complex mathematics.

 

This is a great shame - I'd really like to see this thread attract more contributions.

 

Here's my generic wording of something very simple and, I think, pretty well known - the formula for a fixed-fractional position-sizing:

 

TotalEquity=InitialCapital+ClosedOutP&L

(TotalEquity/100)*PcntRiskPerTrade=RiskEquity

Risk=USER DEFINED {usually based on some kind of volatility measure - eg it could be something like 2*ATR - this is essentially the 'stop-loss' size for a particular trade}

PositionSize=RiskEquity/Risk

 

A trader needs to specify the initial capital, the percent of the total equity to risk on any one trade, and the actual dollar risk for any given trade (this amounts to knowing where your stop would be).

 

Also, you'll need to round the PositionSize up or down to the nearest whole contract/tradeable unit. As I mentioned to someone yesterday, being able to vary this with a finer granularity than the minimum 1 contract for futures is one of the few concrete advantages of things like spreadbetting. It means that your position size can be increased or decreased to the equivalent of a fraction of a contract, which can be very good for small traders trying to build an account.

 

If anyone wants actual EL code to test the application of this within their strategy, just say and I'll post it.

 

BlueHorseshoe

[BlueHorseshoe 10]

I've attached two pdfs. They each show the EC for a strategy in the ES over a ten year period. A non-optimal parameter was used for reasons I can't be bothered to explain, but that's unimportant.

 

The first pdf shows the results trading a single contract.

 

The second pdf shows the results with the fixed-fractional formula I gave above, with starting equity of 20k and a maximum risk per trade of 5%.

 

In the period to the right, immediately after the first very nasty single-trade drawdown, and including the second nasty single-trade drawdown, I was trading this strategy with a 20k account. My plan? Well the idea was to start out fixed-fractional, and then develop a formula that systematically reduced the percentage of equity risked per trade as the equity increased . . . If anyone wants to chat about this or other similar MM ideas then that would be great - position-sizing simply isn't discussed enough on here.

 

BlueHorseshoe

SPR Graph.pdf

SPR Graph with Fixed-Fractional MM.pdf

[BlueHorseshoe 10]

Does nobody want to talk about this!?!?

 

BlueHorseshoe

[SIUYA 11]

Blue---- holiday time in the US - plus my guess is most people find it easier to just rely on single contract sizes....as for a few random thoughts.

 

Re your two charts, everytime I have seen this sort of thing it tells me that when a system is working well you want to ramp it up, and when it does not you want to scale it down. Looking at trade 228 ? shows the problem with the fractional MM.

Have you looked at why that trade occurred - was there anything different about it.

 

Plus your idea of ramping it up from the start then reducing size would go against the best use of this - ie; you have a system that is winning and then you want to reduce its size.....what do you do when a system is loosing?

Mind you people do a variation on this by tracking their equity (though the trade at 228 would not help this)

For me - I try an change the amounts based on what I think is happening - too hard to program.

A lot of this boils down to an exercise in what is the ideal thing to do v what is most comfortable and that works.....of course if fully systemised then it makes sense to apply the best strategy of MM for the strategy...... I wonder if there is a major difference between applying different strategies to mean reverting v trend following?

 

''''''''''''''''''''''''

As an exercise for anyone who has a long list of trades, randomly - every 20 trades, throw in a series of outliers whereby you loose 2-3x what you would normally.

Then do the same whereby you gain 2-3x what you would normally rather than taking profits.

This will tell you more about the importance of making sure you dont have big losses, v trying to get a few bigger wins.....(not exactly MM (position sizing) as it does not tell you how much to buy/sell), but when you apply an aggressive MM section to this, the winners can get bigger once you learn to let things ride a little.

[kayaktri 10]

I was also gone for the long weekend.

 

I would be interest in more discussion of the ideas presented in your two pdf's and possibly gain more insight as to the details on the account losing 50% of the equity in one or two trades. Currently I am using a Fixed Fraction system of calculating my risk exposure and the amount of shares I can purchase for my transactions. I am very aware that I am not optimizing my CAR, but without long term statistical results on my system (I am still building my large sample size of trades to base my stats on), my goal is equity preservation rather than optimized gains.

 

Best Wishes ...

[BlueHorseshoe 10]

I was also gone for the long weekend.

 

I would be interest in more discussion of the ideas presented in your two pdf's and possibly gain more insight as to the details on the account losing 50% of the equity in one or two trades. Currently I am using a Fixed Fraction system of calculating my risk exposure and the amount of shares I can purchase for my transactions. I am very aware that I am not optimizing my CAR, but without long term statistical results on my system (I am still building my large sample size of trades to base my stats on), my goal is equity preservation rather than optimized gains.

 

Best Wishes ...

 

Hi,

 

The 50% equity loss was from one single trade, not two.

 

The reason for this is that no stop loss was used in the backtest. Nor did I use a stop-loss in actual trading. A stop could easily have been used, and this would have resulted in a smoothing of the equity curve, and also a lower net return. Because I was trying to run a small account up (the entire balance of which I could afford to lose) into something worth compunding, I chose to trade without a stop and 'swing for the fences'. What I got in 10 months of trading was exactly what might be expected - a roller coaster ride but with a better net return at the end. I would not have gone on trading without a stop indefinitely, and towards the end of this period I began searching for a robust solution to this problem (I think it's pretty fair to say that I didn't succeed in finding a solution that I thought was acceptable). Obviously all of this is a very personal thing and may not be what most would want to do.

 

I'll repost the ECs above with some sort of stop-loss applied, and that could be useful for further discussion.

 

I'll also post ECs with SIUYA's suggestions applied.

 

BlueHorseshoe

[roztom 10]

I know many of us focus on everything else but put MM last... In reality the goal should be to lay off risk and get to risk neutral asap...

 

Any trades specific outcome is random..now before you tell me you have 60 or 80% winners, can you tell me which one will be the next winner? Can you tell me whether you will have a sting of losers? Nobody knows...all we do know is that we have to manage the risk to stay in the game... So How?

 

I'm going to assume you have a non-random executable setup...

 

You must know what the probability is for that setup to hit a specific minimal MFE and what the typical MAE is.. (based on the market traded).

 

Ex.. If you know the ES has an average 1.5 point counter rotation..wouldn't you want to scale at or just past that rotation to lay off risk... ? If you trade a 2 lot (3 is better) then your goal is to get the first scale.. If you are trading a 2 lot with 1.5 pt risk = 3 pts, then if you scale 1.5 you have no risk going forward on the second contract... With 3 lot you would then have reduced your risk to 1.5pts on 2 lot...Then you would scale #2 at the next logical target subject to your plan and then manage the last runner per your plan...

 

Some will say the R/R ratio doesn't work..I say the probability of getting the scale is the primary initial objective...after that it is up to the market participants to either carry the trade to its objective or for it to fail... That outcome is not under our control... but execution, Risk management and trade management is...

 

I am a discretionary trader. To me it's all about the risk...the profits take care of themselves. Get risk neutral then you've protected your equity and then you can let the trade work... Emotionally it allows you to be more detached from the outcome...

 

Also, make sure you know when the trade fails...it should be something structural, not $ driven if possible...

 

[TheNegotiator 13]

...and basically, the more you can lay off risk, the more stable your equity curve will be. The more stable your equity curve is, the quicker and safer you can scale your strategy up in terms of your clip size. 3 lot turns to 10 lot turns to 50 lot etc. and so your account ratchets up quite quickly.

[72black 10]

I had a quick look at what was on TL already and there seems to be a reasonable amount. If anyone has a particularly useful thread to add, please post it. Anyway, I came up with this one from James, the founder of TL. Pretty useful post really. 12 replies. 12 flippin' replies. I'm not surprised but it does seem somewhat of a shame. But there you go.

 

I believe most are looking for the magic not the reality. Facing the facts would errode the dream of placing positions while sipping a cocktale on tropical beach from the laptop.

[wmck6167 10]

I believe most are looking for the magic not the reality. Facing the facts would errode the dream of placing positions while sipping a cocktale on tropical beach from the laptop.

 

This statement provides a me to think from another angle. Thanks.

I just have a simple question about MM and market. Does the MM lead the trades in market or the trades in the market lead the MM? If the MM leads your trades, you probably can control your risks more efficiently, but if your trades attached to market leads MM(I assume that you are a very talent trader), you probably can have a chance to max. your profit? Am I right? Well, maybe it very depend on your current situation. If you are a fund account manager, learned to MM is very important, but if you are Mr. buffet in young, will he handle the situation as fund manager? Just think it from another angle, cheers.:missy:

[72black 10]

This statement provides a me to think from another angle. Thanks.

I just have a simple question about MM and market. Does the MM lead the trades in market or the trades in the market lead the MM? If the MM leads your trades, you probably can control your risks more efficiently, but if your trades attached to market leads MM(I assume that you are a very talent trader), you probably can have a chance to max. your profit? Am I right? Well, maybe it very depend on your current situation. If you are a fund account manager, learned to MM is very important, but if you are Mr. buffet in young, will he handle the situation as fund manager? Just think it from another angle, cheers.:missy:

 

I use % rule, no more than 3% of account at any one time. So, if I perceive a trade to be highly probable (who knows that anyway? but it's in my rules) I will risk as much as 3% of account. But, for example, I may place 3 trades on so theoretically I could have 1% per position.

 

To answer your question, MM controls my actions as should any trader.

 

For example, when I first began trading I ran my account too low to trade so I withdrew my funds closed the account & reevaluated my trading short & long term systems & most of all myself. Once soughted I opened an account.

 

Hope this answers your question.

[wmck6167 10]

"........To answer your question, MM controls my actions as should any trader. ........"

 

Is there anyone using trades which is interacted with market to lead money management? I just curious. Thanks.:helloooo:

Edited August 30, 2013 by wmck6167

[Senior 10]

Not sure this is a proper topic to ask, but I'm gonna risk it and ask nevertheless.

 

I have a question about rich investors and how they search for investment opportunities.

 

Where/how do they get their information about start-ups and companies in general? Do they have their own personal analysts writing reports for them, or do they simply use the internet like everyone else and do some googling?

 

What would be the exact job title of someone working for a rich investor, something like information analyst?