Complete trading systems for use with MetaStock
Money Management Back Page
Proper money management should address three things: Risk and reward and the overall efficiency of the system ( as opposed to a per trade efficiency ie stop loss - protection).
Money management is something that pertains to your margin account as a whole and is not gauged on a per trade basis.
Contrary to popular belief futures trading is not gambling. For example in a casino, risk is artificially manufactured and engineered in favour of the house. In futures markets we are dealing with natural risk associated with the production and consumption of the materials that make life possible and worthwhile - food, metals, finance and energy products.
The trader decides what he is going to trade based on back testing the system on the securities or commodities that he wants to trade. He then has a positive expectation based on this historical testing
We cannot bend those risks to our will but we do have tools to manage them. Unlike gambling I believe we can move the odds to our favour. To do this we must be disciplined and have a predetermined plan. Read more . . .
There are many money management methods out there and they are lumped into two categories.
Martingale and Anti martingale
Martingale Category simply states that as the value of an account is decreasing, the size of the following trades increases.
This is gambling and has a high degree of risk of ruin. This is a method employed by gamblers trying to take advantage of streaks. This method seems highly improbable of long term success. And for that matter has no basis in mathematical certainties.
In short gambling is a no win expectation situation and no amount of money management will survive in these circumstances.
ie Flip a coin 100 times. You have a choice to bet on either heads or tails up on each flip. However, when you win, you only win $4. And when you lose, you lose $5. This is a negative mathematical expectation. If you were to bet $5 on every flip of the coin, you would lose $50 after the 100 flips.
Anti martingale Category states that as an account increases, that amount at risk placed on futures trades also increases.
The main characteristics of anti martingale methods are that it causes geometric growth during positive runs and suffers from asymmetrical leverage during draw downs.
ie If a 20% draw down is incurred, a 25% gain is required to get back to even.
If a 10% draw down is incurred, a 11.11% gain is required to get back to even.
Some common names of anti martingale methods
Fixed fractional -Optimal F subcategory of fixed fractional - Secure F subcategory of fixed fractional -
Fixed Ratio- my method of choice
Fixed fractional method (It must be stated for reference here that that margin account as a whole is the subject for discussion - not a per trade risk or reward system).
Pros
Geometric growth is possible with higher percentages (risk % higher per trade)
Risk is controlled with lower percentages ( risk % lower per trade)
Cons
Using higher percentages subjects the margin account as a whole to more risk
Using lower percentages takes too long (subjective I know) and is inefficient
You would think that a median could be maintained between what is considered too high and too low of a percentage but in reality there is always a trade off between the two points. At least in my opinion.
I won't get into the details of all the money management methods out there but I believe that money management can make or break a trader. Suffice to say that I have implemented a system that I am comfortable with. And the reason I am comfortable with it is because it is proven mathematically. It is the
Fixed Ratio System Addresses the relationship between growth and risk.
On a direct scale comparison Fixed Fractional and Fixed Ratio the Fixed Fractional method the geometric growth of the Fixed Fractional (FF) is almost double that of the Fixed Ratio (FR). Although that is a direct comparison that doesn't take into account risk and the fact that FR has less risk.
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As the number of contracts increases within the FR method the amount required for the next increase in contracts increases exactly proportionally. As a result, the risk decreases far below that of the FF method.
A basic comparison between Fixed fractional and fixed ratio (For this comparison 10,000 level must be reached before another futures contract can be traded).
FF It will take 19,375 in profits based on a single contract to reach 70000
FR It will take almost 40000 in profits based on a single contract to reach 70000
For Fixed Fractional method a standard of 10000 per commodity contract must be gained before another commodity contract is traded. (for reference ) The same goes for a decrease in the margin account 9999 and less and one contract is traded.
Because the Fixed Ratio method has less risk a smaller fixed ratio may be used. That is a delta of 5000 for every commodity contract traded( margin of contract must be below 1500). Without getting into too much detail this will decrease the risk on the long end of trading as opposed to the fixed fractional method. And still allow for substantial geometric growth.
With this example, The FF is using one contract for every 10000 in the account and the FR is using a delta of 5000. As a result, it took the FR 20000 to reach the 60000 level instead of 40000 to reach the 70000. Further, another 5000 in profits would take the account to 85000. Therefore the geometric growth is starting to kick in.
.The formula for calculating the levels at which contracts are increased is as follows:
| Previous required entity + (number of contract x delta) = Next Level |
| 10, 000 + ( 1 x 5, 000) = 15, 000 to increase to two contracts |
| If the account balance goes above 15, 000 then 15, 000 becomes the previous level in the equation |
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15, 000 + (2 x 5, 000) = 25, 000 25, 000 + (3 x 5, 000) = 40, 000 40, 000 + (4 x 5, 000) = 60, 000 |
Rate of decrease for the fixed ratio method is independent of the rate of increase.( as opposed to the fixed fractional method) The purpose of this relates to profit protection and geometric growth enhancement.
Faster decrease in the number of contracts traded negatively affects the accounts ability to make up the decrease in profits! Therefore a slower decrease in the number of contracts traded does not adversely affect the accounts ability to make up the loss ( to a point that is).
The rule of thumb that is implemented in the Momentum Profile System is to decrease number of contracts traded at half.
Scenario
20,000 account that will increase to two contracts traded at 25,000 level.
At 23,000 a winning trade puts account to 25,000 and 2 contracts are now traded. Next trade is a loser @ 1,000 but for two. Account is @ 23,000 again. (Back to one contract traded). Next trade is a 2,000 winner Account back to 25,000 (Back to two contracts traded). Next trade is 1,000 loser again but for two . . . back to 23,000 again and 1 contract traded. See the cycle.
Same scenario but don't decrease number of contracts traded.
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20,000 account that will increase to two contracts traded at 25,000 level.
At 23,000 a winning trade puts account to 25,000 and 2 contracts are now traded. Next trade is loser @ 1,000 but for two. Account is @ 23,000 (no decrease in contracts traded) Next trade 2,000 winner but for two. Account is 27,000. Next trade 1,000 loser and for two . Account is @ 25,000. Point is that progress is slowly being made with the slower rate of decrease.
I am comfortable with this FR method of money management. It allows the greatest amount of growth in relation to the amount of risk required.
I utilize a delta of 5000 and a draw down decrease of 2500.
Risk Taking
When people start out trading they often start small. As they get better they trade more. They might start trading 1 contract and then move to 10 contracts. As time progresses, they reach a certain comfort level and maybe they never reach trading 100 contracts or 1,000 contracts.
Remember you want to try to keep things in constant leverage terms. You always want to trade the same as your equity increases. When you employ the Fixed Ratio money management approach you are never afraid of getting big. You are prepared. You know what you will do in advance as your account grows. This is a key to successful money management.
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