So I have been refining my money management techniques. I have been focusing more on entries, exits, trade management. But I felt like it was time to concentrate on some other part of my trading. So I started reading up on some different techniques to limit draw down. But as we know in trading nothing comes without a cost, would you trade in 30% of your net profit to reduce your max draw down by 30%? How much is draw down reduction worth to you? How about in context, if it alters your average trade value positive or even negatively, or increases your win rate by 1%-2%. But in the overall picture of things because its pure money management your systems R ratio stays about the same, less than .05 R change.
What would you give up to reduce your Max Draw down?
HEY
I’m still new, but I am learning so gonna try and give some thoughts
Yeah, so I understand that risk & success rate although somewhat correlated, are separate variables that you have to consider when developing your trading plan.
You establish your maximum (say 1.5% per trade) and based on that risk you develop an exit strategy, and if that exit strategy is not profitable enough for you then find a different one!!! Either that or your trading strategy needs work.
If you’ve ever read market wizards, etc. almost everyone has a maximum risk of 1-2% and these traders are making $$$$ That’s because they fix their risk variable, and concentrate on psychology, an exit strategy (How can you let your profits run??? Maybe close part of your trade and let the rest keep going to try to increase your profitablity per trade), and a trading strategy.
Just my thoughts. I suppose you then have to calculate a success ratio for your trading strategy in order to figure out maximum drawdown??
To conclude: to change your maximum drawdown you can’t touch your maximum risk, you should rather tinker with your exit strategy/success ratio… you think?
I’d like to year your thoughts because I’ve been trying to understand money management for a while now as I build a trading plan.
Good thoughts and thank you for the reply. I have read all the market wizards books and they are great
. But this money management strategy has nothing to do with altering your entries, or exits. your trading system as you have it set up now is completely intact. Maybe I wasn’t clear on that. This is just altering how large you trade or when you stop/start drawing after consecutive losses or whatever parameters you look at. If you increased your max risk %-age it would mostly likely increase your max draw down, and definitely increases your risk of ruin. Which is counter to the goal here. The effects on net profit, win rate, PF ratio, R ratio and anything else are by products of running the set of parameters I was studying, they are not the variables I am changing.
For example, take someone who loses 3 consecutive trades then reduces there risk by 50% until they return to the point at which they started taking their first loser. it would necessarily take them twice as long to regain that lost equity at the 50% risk than it would if they held that risk % constant to the original trade, however it reduces their risk of ruin and decreases the depth of their draw down. So in this hypothetical scenario we have trader 1 who holds his trade % flat as you mentioned above, and trader 2 who reduces his % risk after 3 losses. Both trade identical systems
In draw down mode: Assuming they continue to take losses
Trader 1 fixed: (-3 from the start) , -1 ,-1 ,-1 = -6
Trader 2 reduce: (-3), -.5, -.5 , -.5 = -4.5
Trader 2 has saved 1.5 trades worth of equity over trader 1
here is where the stats come in and why they are altered purely on money management, not because they altered their systems.
Since Trader 1 will win every time trader 2 does, because they trade the same system. By the time trader 2 gets back to even, trader 1 will have netted +3 trades profit. So Trader 2 lost 3 trades of net profit compared against trader 1. However
Trader 2 only experienced 75% (4.5/6) of trader 1 draw down.
I hope that sheds some light on what I am trying to describe or talk about, i could use a random number generate to come up with trades and run them side by side but its a lot of work. So the trade scenario is not realistic at all but i think it sheds some light on my point.
It sounds like you’re talking about Harry Markowitz’s efficient frontier. This is the tradeoff between risk and return.
But what if you didn’t have to give up return to reduce risk? Free lunch? What if…
Harry Markowitz put forward this model in 1952. It assists in the selection of the most efficient by analyzing various possible portfolios of the given securities. By choosing securities that do not ‘move’ exactly together, the HM model shows investors how to reduce their risk. The HM model is also called Mean-Variance Model due to the fact that it is based on expected returns (mean) and the standard deviation (variance) of the various portfolios.
Curtis Faith covers this very well in ‘Way of the Turtle’. He looks at the process of optimising a strategy without overdoing the curve fitting aspects
Don’t limit your draw-down or you will skew your trading edge. Take each trade as you would any other trade. The question should rather be after X% amount DD should I keep my balls of steel and continue without changing anything, or stop for a period of time until demo results have moved back to the expected.
Changing anything that is not already built into your trading strategy which has been tested will give a complete different set of results. Stick to what you know, and work on limiting by either stopping or continuing, keeping the actual trading strategy constant.
These are some of the ideas I am testing. After x% stop, reduce size, or move back to demo. I have tried to stress that these money management techniques are not altering the trading strategy in any way. But it seems people keep assuming thats what I am altering. This is not pointed at u jezzer just in general. Using tools that stop or start trading, reducing size, etc all have effects in the overall statistics of your system. I have been trying to get to that but I seems either I am being stubborn or I can get that idea across. As with anything all of these methods should be backtested and analyzed thoroughly, this is actually how I discovered the range of effects on the statistics of my baseline systems performance.
The most efficient money management strategy is to use a fixed lot. I have tested hundreds of ideas. Still the most efficient is not to change the lot size. Going up or down in lot size, makes no mathematical sense.
But shouldn’t I decrease my lot size as I am losing money? no. If you know your system, prepare for the worst draw-down beforehand. Don’t trade a lot size that is too high for your system.
Actually i did improve on the fixed lot. Make sure your lot is a % of the account size to start with. Never lower the lot size. Only go up in lot size as your account balance improves. It is the same as trading a fixed lot, but variable.
As you say, this has nothing to do with the strategy. and the percentage you trade is up to you.
