Money mangement discussion

Beginner Questions
1

hi everyone, i wanted to talk about money management and risk management. I haven’t done much thinking and development in this area despite it being the most important topic.

I wanted to grasp everyones understanding on there idea of MM in terms of what they follow. I know some follow the “2% rule” and reduce to 1% when they lose. This is a safe and standard way.

However, ive been reading this book and coming across the MM topic they introduced a MM formula which was introduced in 1956 this is called the Kelly formula.

here it is…

F= ((R+1) ⋅ P-1)/R

where
F= is the amount using each trade
P= percentage accuracy of system
R= ratio of winning trade to losing trade

I attempted this formula myself but i found that this gives a result of high risk high return whereas, 2% risk is a safer option leading to possible liquidation of acct slower and less likeliness

for instance lets take an account with $10,000 if we use our standard 2% risk rule, we trade $200 ea trade (FYI this is not including margin) meaning we hypotethically can be liquidated fully after 50 losing trades in a row (using 1:1 ratio).

whereas for the formula.

lets take
P=60%
R=1.5

F=((1.5+1) ⋅ 0.6 -1) / 1
F=0.3 OR 30%

meaning we risk 30% of 10,000 ea. trade
=$3000.

now compared to the other strategy this is insane. I wanted to hear your thoughts on this

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2

Interesting point you have discussed. Prior to reading your article, I was unaware of the Kelly formula, thus, I did some research into the same. Based on the literature I have read thus far, the Kelly formula, or Kelly criterion,

“is a mathematical formula used to determine the optimal percentage of one’s capital to allocate to a single investment or bet.”

One key element I observed is the Probability of winning, which, to me, is a critical component to this formula, as with any other formulae, in regards to ascertaining the “ideal” risk parameters for placing a trade. In retrospect, in some way or another, most traders do the same, wherein, if they are “sure” about the outcome of a trade, they risk more of their capital.

Based on your example and what I am understanding of this formula, I call insanity :joy: as one, can never be too “sure” about the outcome of an asset’s direction, save and except, insider information :business_suit_levitating:.

In my own experience, and opinion, I will always advocate for lower risk, as to survive the many drawdowns to achieve the many rewards in the long-term.

Albeit, each trader has their own understanding and comfortability for risk allocation. For me in particular, lower time frames(scalping), I risk 0.4% of my capital, whereas for swing trading and or position trading, I feel more comfortable with risking anywhere between 1-2%.

It really comes down to, what works for you. I do not believe that any one person can “know for sure” the credibility of their analysis being 100% accurate to prompt risking an insane amount, as long-term it is not sustainable. Slow and Steady wins the race, and as the account grows, perhaps maybe the risk too.

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3

hi @TwinIslandTrader, exactly i like this statement here. I’ve only just learnt about this formula 15-20 minutes ago. I want to test this theory perhaps on a demo or cent ACCT.

the book is called long term secrets for short term traders by Larry Williams (well renown trader). he has the evidence of this theory in his book to work, however, it is extremely risky. He states he turned $10,000 to 2.1 million in 19 months, however, dropped his acct balance back to $700,000 after going on a streak of losses. that is the danger of this formula high risk high reward

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4

Hello, @tomo22. Yes, Larry Williams actually did make an astonishing 11,376% ROI in the 1987, World Cup Championship of Futures Trading, which is still undefeated to this date. I came across the book a few times as a recommendation to read many years ago, but I have not. Whilst it may have worked, we can see the pitfalls of such an application, from 10,000$USD to 2.1 million $USD back to 700,000 $USD, that is steep. An incredible win with an incredible drawdown too.

As you have said, high risk, high reward.

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5

My view on John Kelly - very simple -

A TOTAL AND UTTER MAD MAN

Who should have been certified insane!

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6

Hey

This is a really interesting topic! The 2% rule is definitely safer and helps you avoid big drawdowns, which is crucial for long-term survival in trading. I get the appeal of the Kelly formula—it’s more aggressive and could give you higher returns—but risking 30% per trade sounds risky, especially for new traders. For me, consistency and small risks like the 2% rule feel safer and more sustainable. But I’d love to hear what others think about balancing risk and reward!

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7

hi @TwinIslandTrader and @Margaretwantstotrade , just to add to this.

I finished his MM chapter. He concludes after noticing the massive drawdowns of kellys formula and admits he no longer or recommends traders to use it for obvious reasons :laughing:.

After his friend Ryan jones who is quite versatile in MM and has extensive knowledge in it he critiqued the Kelly formula and in turn developed his own which is called ‘fixed ratio money mangement’. pretty much his key idea is the Delta Concept, where a trader increases position size after reaching a predefined profit threshold (Delta). This allows for controlled, exponential growth.

after taking this into acct larry comes to a conclusion and this is his final formula

(acct balance x risk percentage / largest loss) = contracts/shares to trade

for instance

$10,000 x 0.02 / 1000 = 0.2 lot??? im not sure how this works in forex maybe others can help :smile:

8

thanks for the information, I couldve guessed, 30% cannot last!

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9

yes, 2% rule is good and 30% may be too much. larry emphasizes that good MM is key, not safe nor hyper. perhaps maybe 2% can be considered bad, because yes we wont blow our acct but perhaps we arent making as much profit as we could be. Maybe its 5% 10% just throwing numbers here. My idea is that i feel theres more out there then 2% rule i feel thats standard. I feel more depth needs to be looked into this topic considering this is probably the most important topic in trading

10

… and maybe even was (or would be, these days, anyway!). :crazy_face:

People posting in beginners’ forums tend to think it’s good, anyway. People trading for a living get palpitations from it and think that 0.5% is a much better idea.

It depends on your perspectives.

In forums, people seem to latch on to “widespread ideas” and they gradually become more and more widespread, however silly and/or exaggerated they were in the first place.

And then that becomes “online information” so it’s fed into bots as part of their learning process, and they also repeat it all over the place.

That’s how these silly myths become accepted.

The reality is that an appropriate % position-size depends on many statistical factors. Not only the win-rate and R:R combination, but things like MAE/MFA as well.

The subject’s much more complex than most people realise, but 2% is HUGE.

But stay well away from Kelly! :stuck_out_tongue:

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