Thank you! Sorry for crediting your sharing to someone else, now I am giving credit where it is due, really appreciate it!
You picked exactly the issue MM is called upon to resolve. It doesn’t add chances to win but allow to cut risks or at least allocate them evenly on your deposit.
Rambo,
I concure. One thing I’m learning is that MM and Trading are two different beasts. Each has it’s own skill set that needs to be mastered.
I find myself looking at pip targets only to see that I’m above my monthly goal of profit. Do I stay in the trade or close it out and take my profit.
One thing that my mentor mentioned and one mantra I now keep in my mind is that I’m here for one thing and one thing only. Make money.
Many traders believe they should invest a fixed percentage - such as 1%, or for the more daring, 2% - of their account balance per trade. This is one of the most common reasons of unexpected margin calls, especially with automated systems. Here’s why:
The maximum drawdown of any trading system increases over time. The longer you trade, the higher is the probability of a long loss streak and the bigger the depth of the drawdown. That’s why a system, tested over 10 years, has a worse maximum drawdown than the same system tested over only 5 years. When modeling drawdown depth mathematically with a diffusion model, the maximum drawdown of a break-even system is proportional to the square root of the number of trades, and therefore also to the square root of the trading time. This also means that drawdowns have no limit. A trading system will suffer a drawdown of any depth when you wait long enough.
Drawdown also increases with the invested amount: When investing twice the volume you’ll get twice the drawdown. Thus, when you reinvest a fixed percentage of your balance, the maximum drawdown grows with the balance. And the balance of a profitable system also grows proportional to the trading time.
When summing up both effects, you’ll get an overproportional drawdown growth by trading time: the drawdown grows proportionally to time to the power of 1.5. The 1 comes from the reinvested profit, the 0.5 from the square root of the number of trades (in fact the exponent will be slightly higher than 1.5 as reinvested profit also grows overproportionally, but that shall not bother us here). In any case your drawdowns will grow faster than your account balance. At some point, a drawdown will inevitably exceed the balance, causing a margin call. That will happen later or sooner, dependent on the system and the reinvested percentage.
Therefore, better don’t invest a fixed balance percentage, no matter how often it’s recommended in trading books or seminars. There are several methods to overcome the drawdown growth issue. One method is to reinvest only an amount proportional to the square root of the capital growth. Thus, when your capital doubles, increase the trade volume only by a factor of about 1.4 (the square root of 2), i.e. 40%. Example: You’re trading with a Margin of $50. Your account doubles from an initial $1000 to $2000. You can now increase your Margin to $70 (= 1.4 * $50) for reinvesting your gain.
Another method is investing a variable percentage - for instance the Algorate factor, - that is calculated from the real equity curve and regularly updated so that it decreases when the drawdowns increase. In both cases, the drawdowns of your system will then only grow at the same rate as your account balance, so you stay away from a margin call.
I have some good experience with Algorates investment hose about draw downs.