my journal 2

[Yamato]

money and risk management

Today I need to study money and risk management, because I realize that I need to automate them better.

But it's hard. I've been working on this for years and I still have not found a good way to automate it, so that I don't have to constantly monitor how many contracts which of my systems are being allocated. One of the reasons why money management is so hard, besides the fact that I am bad at formulas, is that it's hard to appraise my systems' performance.

The most basic principle would be:

1) Let all profitable systems trade 1 contract.

But then of course, if capital is limited, we should favour the best systems, so I created formulas to appraise which are the most profitable systems and implemented this money management:

2) Let the best systems trade more than the others.

Then I realized that it's not just a matter of how much profit, but also how much they could lose during a drawdown, so:

3) Let the best systems trade more than the others, and measure performance by profit AND drawdown.

Then I realized ROA wasn't enough, and I included Profit Factor.

4) Let the best systems trade more than the others, and measure performance by profit, drawdown AND profit factor.

Then I realized I also want to know how often and how deeply a system incurs drawdowns, so I measured this with my simple formula of average deviation, which is not too bad, I guess. Since alone it would not be a good indicator, I divided profit by average deviation.

5) Let the best systems trade more than the others, and measure performance by profit, drawdown, profit factor AND average deviation.

Now, it would seem my appraisal of performance is complete, and maybe it would, but, with a small capital of a few thousands, strange things happen, like the best systems not trading because risk management doesn't allow them, which brings me to another ingredient: risk management, which in my own vocabulary I use to define my control over losses. I never allow a system to incur a loss bigger than x% of total capital. While I would define "money management" as deciding how much you should allocate to each system based on the "good" side of a system's performance (mostly the profit it makes), I consider "risk management" as something to protect me from excessive risk. Traders use and misuse these two terms in so many ways, and this is the only way I could make sense of them, for now.

So this brings me to the present definition of my risk and money management formulas, which I still don't find satisfactory nor self-sufficient:

6) Let the best systems trade more than the others, and measure performance by profit, drawdown, profit factor and average deviation. Make sure no system can lose more than x% of capital.

In the past I've downloaded, via emule, dozens of .pdf books on money management, but of course they need to be read, which is not easy at all, considering each book doesn't approach it with a quick answer, but needs to be at least 100 pages long (as all books are) so it starts discussing money management from the middle ages, and basically is filled up with a lot of god damn bull****. But that's what you have to do to get your book published: if you can say it in 10 pages, they won't publish your book, so you have to fill it up with bull****. It's like a natural selection all reversed: only the people willing to write bull**** get published. The others are probably writing on forums, but it's quite hard to find their stuff among the sea of smilies and bull**** in forums.

So maybe I will try to see what I can get out of wikipedia, which is probably the best combination of both worlds (academic bull**** world and forum bull**** world).

Obviously I went here first:
http://en.wikipedia.org/wiki/Money_management

But it's no good. Except that it tells me to read this book, which is a good one actually and I have it:

Balsara, Nauzer J. (1992). Money Management Strategies for Futures Traders

Until now, the best wikipedia entry I remember reading on money and risk management was this entry:
http://en.wikipedia.org/wiki/Kelly_criterion

But let's check out "risk management", just in case:
http://en.wikipedia.org/wiki/Risk_management

As I read this stuff, i need to remind myself constantly that I don't give a **** about being an academic and that I should stick to the original point of making money. It's hard to remember this, when everyone writing this stuff is busy making himself look good and knowledgeable. These people don't care to be useful to me: they just want to show off their knowledge. Like the "look elsewhere" user.

Anyway, the wikipedia entry is no good. So we're left with kelly criterion as far as wikipedia.

You see, my problem is that whereas it's easy to see which systems are the best, and I've done that and even automated it, it's not easy, when you have enough capital to allow your good systems (and the others) to trade more than 1 contract, to automate the allocation of these extra contracts.

Maybe I should completely separate the risk from the money management part...

Let's first discuss kelly. Kelly is great, but, with 40 systems, it gets too complicated to use it, at least with my low skills at using formulas.

So let's see if I am at least doing what he considers to be right. Other than the kelly formulas, the most important stuff I found on that entry is:

Reasons to bet less than Kelly
A natural assumption is that taking more risk increases the probability of both very good and very bad outcomes. One of the most important ideas in Kelly is that betting more than the Kelly amount decreases the probability of very good results, while still increasing the probability of very bad results. Since in reality we seldom know the precise probabilities and payoffs, and since overbetting is worse than underbetting, it makes sense to err on the side of caution and bet less than the Kelly amount.

This is telling me to stay on the safe side in case I am not sure of my edge and drawdown (and I am not sure), because, if I underbet I will simply increase my capital more slowly. Whereas, if I overbet, I will blow out my account.

Forget the books, as they are too long and too hard to make sense of them. It's best to do it by myself in depth, than to read books superficially. I know what I want - I will figure it out by going back to my excel workbooks.

Let's take care of risk management (as I intend it) first. We want to separate the two completely.


RISK MANAGEMENT

The way I mean "risk management" is just to make sure that if a system incurs its worst possible loss, it won't exceed x% of capital. That "x" will vary depending on how much capital I have: I will define that "x" arbitrarily, even though I am aware that Larry Hite and others have said it should be no more than 1%. But I don't have their money.

I have estimated the worst possible loss by each system as an average of max drawdown (back-tested and forward-tested) and max loss during forward-testing, just in case my forward-testing sample isn't large enough.

I will now also add a rule that says if the foward-testing trades are less than 20, no more than 1 contract should be allowed.

[...]

After much thinking and tweaking, I have reached a solution:

1) I have finally given up on my plan to entirely automate risk and money management. Better to do less but well, than do much more but not well.

2) I have entirely separated risk management from every other column (no connections, no "dependents" functions). Now it calculates just this:
=-s!$B$20*s!$B$25/mm!C2
Capital multiplied by % of capital allowed to be lost by biggest loss and then divided by biggest expected loss.

If we have a capital of... say 100k and multiply by... say a 5% of capital allowed to be lost by biggest loss, we find out we can only risk 5k with each system. Then we divide it by a max loss of... say 2.5k and we get 2, which means only 2 contracts can be allocated to that system, if we don't want it to cause us a potential loss bigger than 5k. Now this is all automated and it limits our contracts, as it has to do with limiting our risk.

3) Now, on to money management. This is the toughest part, and it's the part I've kept arbitrary, or rather "manual" and "discretionary". It's hard because it's hard to appraise each system's performance. I have set up 2 columns:

A) one is the (automated) rating of my systems, based on my custom index I've spoken about in previous posts. Such index relies Return On Account, Profit Factor, Average Deviation. Each system's index value in turn gets weighed against the best system's value and then multiplied by the highest amount of capital I want to allocate to the best system:

=s!$B$23*(P2/s!$B$24)/B2
% of Capital allocated to best system times how well a system is doing compared to the best system divided by margin

Say we have a capital of 100k, and we decide to only invest 50% of it on our best system (how is it possible with 40 systems? systems do not all trade at once). We then have to multiply that 50k by how good a system's performance is compared to the best system, let's say our hypothetical system on OIL is only 50% as good, in terms of the mentioned Index. That CL system will then only get 25% of capital. Then we divide 25k by CL's overnight margin of 5k, and we get a result of 5, which is the suggested amount of contracts to be traded.

B) I then decide with my discretionary manual column if everything seems right and I am willing to let the CL system trade 5 contracts. Let's say I do, and have written a 5 to confirm that. That 5 will stay there no matter how much capital increases, so the system will only be allowed to trade 5 contracts until I check on it again and manually change that figure. The A) column, with the Index allocated contracts is only advice to me, but it doesn't affect the trading. The trading contracts get decided by two columns: the one with my manual choice and the risk management column, which in this case would limit contracts to 2 probably, because that very good CL system happens to lose too much.

 

[Adamus]

Re: money and risk management

You should look at fixed fractional bet sizing as well. By Ralph VInce. However I'm pretty sure you'll hate his books because they use lots of equations and formulae. Maybe there's a non-maths guide to fixed fractional bet sizing - also known as 'optimal f' where f just stands for fraction.

You need a good handle on what your maximum loss could be. Although in theory it is pretty much unlimited.

If you don't find anything I can try to outline the idea for you, since I need to refresh myself on it anyway. It's pretty convincing to me that it's the best way to maximize geometric growth of your account and you can operate it across multiple trading systems and markets. However it does have a weak point (the requirement to know the max loss).

 

[Yamato]

Thanks for the recommended book full of formulae, but I am ok without formulae for now. So to speak. Certainly I am not a fund manager or anything. But I am ok because, since I suck at formulae, I think about these matters 10 times as much, about these matters and about all their possible implications. With a formula I might be able to spare myself a lot of worries, but I can't do it, so too bad.

About the maximum REALISTIC loss, it's taken care of. I hope you don't want to complicate my work by telling me that OIL could go in one day from 90 to zero, because I have bad news for you, and for myself: there's no stoplosses in my systems, and I won't even consider that possibility. If something like that happens, I will simply blow out my account, and hopefully by then I will have some money set aside.

Anyway, once again thanks for making me think of something I hadn't thought about. I am not ready for unexpected events like OIL going from 90 to zero in one day. I am not joking, because there's also LIMIT UP and LIMIT DOWN situations in most future markets. And guess what: I don't have stoplosses in my systems because, with my knowledge of excel, IB and all that, it is too complicated to insert a STOPLOSS order for my trades. It would totally screw up my systems, making them (that little thing, yes) twice as complicated as they are now (BUY or SELL at MARKET).

And, believe it or not, even though I admit it is a problem I wish I didn't have, I consider it a good choice. Better to start immediately with a simple and efficiently automated system, which does NOT solve that remote and unlikely but possible event, than to start two years later because I want to take care of every single problem I might have. Why? Because I could die in the meanwhile, and because i know quite a few programmers who - because they want to do everything perfectly - still didn't place one automated trade with their trading systems after 10 years of talking about it.

 

[Adamus]

OK I won't hassle you about it. It is quite a well known method, I'll see if I can find a graph somewhere. It's pretty easy to see from the explanation he gives, even though he quotes a couple of formulae every now and again to prove he's mathematically competent, that the optimal fraction of your capital is the way to do it.

 

[Adamus]

Last word on this: the chart at the bottom shows the relationship between how much money you end up making "TWR" (what Ralph Vince unpoetically calls "Terminal Wealth Ratio") against the fraction f of your account that you allocate to trading the system you're looking at.

Notice it goes down to zero when your fraction is too big. It just proves that you go bust if your bet size is too big.

What it doesn't show is that your account can also go down to zero even when you don't trade at that fraction. It's the typical ivory tower academic application of theory. You just have to take the useful bits from it, ignore the ivory tower stuff that isn't necessary, or add in stuff to take account of the fact that the future isn't going to adhere to the ivory tower theory.

Found the ideal reference for you:

http://www.dummies.com/how-to/content/the-optimal-f-money-management-style.html

Funny how every page I read about optimal f has criticised it. I guess it's not a silver bullet.

 

[Adamus]

Better to start immediately with a simple and efficiently automated system, which does NOT solve that remote and unlikely but possible event, than to start two years later because I want to take care of every single problem I might have. Why? Because I could die in the meanwhile, and because i know quite a few programmers who - because they want to do everything perfectly - still didn't place one automated trade with their trading systems after 10 years of talking about it.

by the way, i totally respect waht you say here. Carpe diem.

 

[Yamato]

very good link

Last word on this: the chart at the bottom shows the relationship between how much money you end up making "TWR" (what Ralph Vince unpoetically calls "Terminal Wealth Ratio") against the fraction f of your account that you allocate to trading the system you're looking at.

Notice it goes down to zero when your fraction is too big. It just proves that you go bust if your bet size is too big.

What it doesn't show is that your account can also go down to zero even when you don't trade at that fraction. It's the typical ivory tower academic application of theory. You just have to take the useful bits from it, ignore the ivory tower stuff that isn't necessary, or add in stuff to take account of the fact that the future isn't going to adhere to the ivory tower theory.

Found the ideal reference for you:

http://www.dummies.com/how-to/content/the-optimal-f-money-management-style.html

Funny how every page I read about optimal f has criticised it. I guess it's not a silver bullet.

Awesome link, but still has a formula in it, which makes it still too complicated for me. But I appreciated the thought of sending me to the dummies.com web site, as it shows you have gotten to know me quite well (with my dislike for formulae). And this guy does make it clearer.

Of course I agree with your talk about ivory towers.

 

[Yamato]

by the way, i totally respect waht you say here. Carpe diem.

I respect your respect, and I see why you would agree with me that getting things done imperfectly is better than trying to do things perfectly and not getting them done, since you named your thread "Deadline June".

 

[Yamato]

still struggling with money management

Let us first of all define risk and money management.

I would simply say this, as funny as it may sound:

1) risk management is the management of risk (i.e.: worrying about not blowing out your account).

2) money management is the management of money with a focus on how to increase it as fast as possible.

Now, if we accept my concepts above, my problem is with money management right now, because I took care of risk management until yesterday, and now I am done with that part.

The problem specifically is money management with futures.

You see, it's hard to deal with this, not just because I suck at formulae, but also because futures do not mean investing money on something, but using margin.

And there's the other usual problems at stake, all intertwined with this central problem of margin.

Brainstorming:

1) A...

I'll continue from the office, in a few hours.

Ok, back.

In the meanwhile I've sent myself this book:
[eBook Trading] Balsara, Nauzer J. - Money Management Strategies for Futures Traders.pdf

I had read it before, and I don't remember finding any precise solution to my problems, but maybe when I read it I didn't see the problems I see now. So, I'll try to read it again with my new problems in mind.

Getting back to my brainstorming:

- I have established which systems work best, through accurate and reliable formulas.

- I have limited the risk of ruin by monitoring a value obtained by biggest losses and drawdown.

- I have to find out what is the fastest way to increase my capital.

No, I've got it all wrong.

I am still worried about drawdown and possibility of blowing out my account and that's what makes this so hard.

I am not just looking for a combination that will increase my capital as fast as possible: I am looking for a combination that will increase my capital as fast as possible while decreasing my chances of blowing out my account as fast as possible and I have to do all this on 40 systems at once.

This is why it's being so complicated. AND because I suck at formulas.

I can tell I won't get out of this unless I speak to some mathematician, so I'll just quit until I meet one.

I will just recapitulate my present risk/money management (because the two things are clearly intertwined and almost inseparable) until here, because I believe it's pretty good (it works), but neither univocal nor clear nor simple, all of which are no good. I would like to meet a mathematician to come up with just 1 formula to deal with all these problems (the ones in red above).

I guess that mathematician could be Balsara himself and I could read his book again. We'll see. Maybe I should just read between pages 130 and 140, all these sections:

ALLOCATION WITHIN THE CONTEXT
OF A MULTI-COMMODITY PORTFOLIO

USING THE OPTIMAL f AS A BASIS FOR ALLOCATION

LINKAGE BETWEEN RISK CAPITAL AND AVAILABLE CAPITAL

DETERMINING THE NUMBER OF CONTRACTS
TO BE TRADED

Anyway, the present situation is this, in a simplified description, and a comparison to "car pedals" of it:

1) Risk management (yes, I keep them separate, and that's the problem maybe), the brake pedal.

For each system I get a value which is derived from drawdown and biggest loss, and use that as a risk parameter: I can't invest on a system more money than what will cause me a max loss of over 5% of capital. This is just a very quick explanation. This is therefore a risk measurement, and a LIMIT to my investment in each system, but does not tell me which systems are more convenient. It just keeps me from investing so much in a system that will make me risk blowing out my account.


2) Money management, accelerator or "gas pedal"

For each system, I used Return On Account, Profit Factor, Average Profit / Average Deviation to measure performance and rated it on a scale from 0% to 100%. Then I allocate capital according to this scale, and multiplying by how much I want to allocate to the best system, which will score 100% (the others are ranked accordingly).

This money management of mine continues this way: I then divide the allocated money (and up to here everything seems reasonable) by the margin (intraday or overnight) required to trade 1 contract with a given system. This is where I see some contradictions and problems.

But even before this, who says how much I should diversify and how much I should privilege the best systems?

In terms of absolute return indeed it would be more convenient to invest all money on the best system. But then again, it won't trade all the time, so I can also invest on the other systems... so ultimately it would make sense to invest all money available in all systems trading at that time...

You see, it's quite complex.

If we then look at drawdown and Return On Account values, we can find a solution which might help us, or not.

The CL alone has a drawdown of 5k. But if we trade it together with the other systems, the overall drawdown might stay at 5k or even decrease. So does this mean I should invest in all systems at once?

I don't know. I just have endless questions due to my lack of math and statistical knowledge.

I certainly would make more money, and apparently the drawdown stays the same or even decreases.

But maybe only because I got lucky. Indeed, by trading all systems together, I could get unlucky and they could lose all at the same time, and then my choice would not have been so good.

But how likely is it that all systems will lose at once? Am I more likely to blow out my account by trading just one system on 100% or trading 40 systems each on 100% of capital? What if I decrease that %? By how much?

And what about this other question: if I play it very safely, say by allocating 1% of capital to each system and keeping 90% of my capital not used, how likely am I to reach my goal by the time I die?

Also, if I don't use all the systems at once and play it safely, how likely are they to last long enough to make it worth it? Or maybe am I just wasting a good moment to use them, since they won't work in a few years?

I have no answers to these questions above and many more that I am not writing.

The best approximation to answering these questions is looking at my equity curve for the past 9 months, tweak the contract numbers on it, also monitoring how much margin I'd need and how good the systems being traded are (that much I do know). Then I look at how high the equity curve rises and how deep its valleys are, and I get a pretty good idea of how much I should have allocated to maximize returns and minimize risk (minimize fear, which would happen if I incur a big drawdown). But that's the past: is that a guarantee that because I can make that curve look smooth in the past, it will also look smooth in the future? Probably better than if I get that curve to look bumpy even for the past.

Some things I can just guess, without the help of formulas.

1) The more systems the better.
2) The more markets traded by the systems the better.
3) The combination of contracts that makes the curve look the smoothier and with the least drawdown, should guarantee less drawdown in the future

I am positive about the first two. The third is a "probably".

Now I'll print those 10 pages of Balsara, to see if they enlighten me.

 

[Yamato]

eureka about money management

I was brushing my teeth and I just went "eureka" so to speak.

I need to find a way to monitor, for any given capital all used as margin, average daily profit / average daily deviation (simplified sharpe ratio) for different combinations of contracts allowed and then come up with best value.

 

[Yamato]

average deviation formula all screwed up

Damn me!

That formula I am using doesn't work at all.

Calculating average profit / average deviation is total crap, man and I i just realized now, incidentally. What a god damn moron I am!!!

If I divide average profit / average deviation this is what I get.

For:
1
0
1

= 1.5

For:
1
0
3

= 1.2

So, listen to this: the second system is actually worse than the first, while actually it's the other way around.

Gotta fix this crap as soon as I get home!!! Either by getting rid of average deviation or by getting rid of the average profit deal.

**** this crap. I am getting rid of it altogether. I don't want to complicate things uselessly. The Sharpe Ratio and its advocates almost got me, but luckily after taking xanax I woke up to the reality that this is all useless crap. My systems can be appraised more efficiently with just Return On Account and Profit Factor.

**** the Sharpe Ratio! And **** the ****in' Diaz brothers! **** 'em all! I bury those cockroaches!

Better to do things by the naked eye, than using formulas you don't completely understand. I will look at the chart and see how good it looks and tweak contracts accordingly (also based on ROA and PF).

 

[Adamus]

Re: still struggling with money management

[eBook Trading] Balsara, Nauzer J. - Money Management Strategies for Futures Traders.pdf

....

In terms of absolute return indeed it would be more convenient to invest all money on the best system. But then again, it won't trade all the time, so I can also invest on the other systems... so ultimately it would make sense to invest all money available in all systems trading at that time...

If Balsara mentions optimal f, then he bases his money management on Ralph Vince. I'd be interested to see if Balsara is any good. Is that freely available or paid for? Where is eBooks? Amazon?

Re your 2nd paragraph quoted above, perhaps it would be more convenient for you to invest in just one system because it would be less work, but it would be a lot more risky. Multiple systems are more likely to have drawdowns at different times which balance out, if the systems are not correlated very much. Determining correlation isn't so difficult - I had to do it myself, so it must be alright.

You can constantly recalculate the allocation of capital to each trading system, so that any trading system that goes into drawdown still gets the same % of your capital. If you had only one trading system and it goes into drawdown and loses 50% of your capital, it would take a lot longer to get back to where you were. If you're diversified and constantly recalculating the allocation, that trading system carries on with the same bet size (rather than reduced bet sizes due to losses) so as soon as it starts building profit again, it will do so faster on the bigger bet size.

The disadvantage comes when your trading system decisively stops working - it would not just lose that little bit of your capital that you first allocated, it would carry on
bleeding your account until you pull the plug on it, since you reallocate capital to it in the expecatation that it will turn around.

 

[Yamato]

I will send you my .pdf book, via email. It's used but it's in good shape. Of course, you're expected to return it once you've read it.

It's a very good book. I actually read the whole thing. Very interesting to me, but somehow I couldn't use it in my own money management formulas, but something must've stuck to my brain in some ways I ignore. The fact is that I read the entire book and that's very rare for me. I must have read 20 books in the past 20 years.

Anyway, I was going to send it to you but now that I think of it, don't you know how to use emule? There's plenty of copies of that book on emule.

Ok, I'll still send it to you if you don't find it on emule but I'd need your email. Plus you have to promise to return it within a month, because I might need it. I mean, get your own copy on emule: why do you have to borrow mine?

Maybe we should meet on msn, so I'd send you not one but ten money management .pdf books I found on emule.

My problem has never been finding books right on my subject but reading them. Just now I was looking at this one: "Elsevier - Quality Money Management - Process Engineering and Best Practices for Systematic Trading and Investment - 2008".

It looked very interesting, at least by the titles of each chapter, but then I picked a chapter and started actually reading its content, well beyond the title, and, as usual I was disappointed: he started telling it from prehistoric times and stuff:

In Japanese, kaizen means continuous improvement. As a business strategy, kaizen aims to
eliminate waste in business processes. For our purposes, kaizen is the process of continually
searching for and implementing new quantitative methods...

Don't do stuff like that! I am reading a book to learn how to make money faster. Don't tell me about your "kaizen" god damn it. That's why I can never read a book, because he has to dedicate it to his family, then one page of acknowledgments, then he writes a preface for 10 pages, then introduction, then something else. Then you finally make it into the book, and he talks about "kaizen" and that's when you say: "**** you, and **** all books!". Academic mother ****ers, wasting my time...

I dedicate this post to Jack Schwager, who didn't write any bull**** in his Market Wizards book.
Acknowledgments to Adamus for our long years of research together.
Post-face (preface goes before, postface goes after), borrowed from the above book:
This post began several years ago as an attempt to provide a detailed road map for students to follow from the theoretical quantitative finance taught in graduate school to building a trading/investment system to manage real money in the real world. From our years of consulting and experience in building funds...

I say: if the mother ****er who invented the wheel has me read a book with 50% "kaizen", I say: let's reinvent the wheel. Let's reinvent money management. I am not taking this crap.

The whole money management deal could be summarized in one wikipedia entry or one post. And probably it is. But it's hard to find. On the other hand, there's these academics, who, instead of summarizing things, they try to make them more complicated, redundant, and anything but to the point. Why does every book have to last 150 pages? What is wrong with writing a book that lasts 20 pages. Why do you necessarily have to scare everyone off? Even for those who actually make it to the end of all these god damn books, their initial question is gone by the end of the book. All their curiosity was killed. And they're left brain-dead by the whole talk about "kaizen". You either become a brain-dead academic, or you can't read what they write, so be careful when you start reading one of these books. They're not only useless for trading but may cause brain damage.

Speaking of brain-dead, I have just thrown away that xanax bottle because it was making me brain-dead on top of making me wake up at 4 AM and making me sleepy all day long. It makes you sleepy when you can't sleep (during the day) and it makes you wake up at night. What the hell is that thing for? Not for me. I threw it out.

Marijuana is a much better medicine compared to it. It makes me forget my worries, if necessary even sleep and it puts me in a good mood. Too bad I could go to jail for buying it so it's really not something I can have in my house that easily. But what's good about marijuana is that it has no side-effects, does it? I don't remember any. It just makes me forget my worries, but I don't get fat, I don't damage my health like with alcohol, and I don't become braindead like when you take that xanax sleeping aid. Also, another good drug is melatonin. No side effects either.

http://www.megavideo.com/?v=J1L2RJGF

I am watching Extract, the movie at the link above. It's good. By mike judge, the creator of beavis and butthead:

http://www.youtube.com/watch?v=UWqj7OKXSoA&NR=1

Here's another great movie by Mike Judge:
http://www.letmewatchthis.com/watch-5488-Idiocracy

 

[Yamato]

done it: gotten rid of average deviation

Believe it or not, it was returning similar values as ROA and PF, so I didn't lose much. It's not surprising if you think of it: money gained over drawdown, money gained over biggest loss, money gained over average deviation, money gained over investment made... most of these performance measurements have profit on the numerator. Essentially we're always measuring profit, and, if a system makes a lot of money, you can't really change that. If a system has a big drawdown it will most likely require a lot of margin, but out of the two, it's best to weigh your system on the drawdown and biggest loss rather than on the margin required.

The truth is this: you're better off spending your energies building as many systems as possible on as many markets as possible (hundreds if possible), than at working on money management formulas.

When you don't have enough money to invest on systems, risk management is not an issue any more, because you're diversified up your ass.

You don't have to write a whole book on money management, all you have to give out these pearls before swine: be diversified up your ass. Don't bother with any formulas. Just build 100 trading systems. Use the ones that work twice as much as the ones that don't work as well (but still use all profitable systems you have), and don't worry about anything else.

 

[Yamato]

still can't sleep

I don't know if it's the side effects of having stopped to take xanax after using it for 3 days, or what. I have thrown it away yesterday. I didn't take any since Friday, 4 days ago. And yet this morning, despite taking melatonin and being dead tired, I still woke up at 5 am. After just 6 hours of sleep.

It could be that I'm worried about my trading, or about work, or about having been invited to dinner today by someone and not wanting to go, yet knowing I'd be rude to not go, so trying to make myself feel so sick that I'll be excused.

I think it's the mother ****ing xanax. That crap is no good, like most other medicines. It didn't do its job in making me sleep and it really screwed up my mind in terms of memory. I am making incredible spelling mistakes as I write.

I wrote earlier "I woked up". I just went back now and corrected it. I never wrote anything like that before.

I never used to make spelling mistakes. That xanax is something that damages your brain permanently, or maybe just for one week after you take it, hopefully.

Besides, there's a bug flying in my room, and since the room is dark, it's flying next to my computer screen and it's bothering me, but since watching that documentary on evolution, this fly now seems like a relative to me, so I can't kill it anymore.

Here's what I'll do. I'll eliminate all worries, one by one. And hopefully the memory and the spelling mistakes will disappear by themselves. The fly can live.

The dinner must go. I will call the bitch, and tell her that I am not going. I'll write her a text message right now telling her the truth: "I can't sleep so unfortunately I won't be able to come to dinner tonight. Besides, it would keep me from sleeping well for tomorrow, as always happens when I go to dinners on weekdays".

I also have turned off my alarm, so I will just sleep without worrying about waking up to go to work. If and when I'll wake up, I will go to work. **** them all.

I will also open a bottle of wine, to see if that helps me sleep better. It definitely will do so better than xanax. I will open it and leave it there, without drinking it. No. I will just take it and put it under my pillow, without opening it. It works that way, too. Just thinking of being able to get drunk makes me go to sleep better even without getting drunk. Just the thought that if I want I can get drunk.

As i said or thought before, the illegal drugs actually hurt you less than the prescription drugs. Marijuana doesn't cause me any side effects. It does exactly what I want, without knocking out my brain for an entire week or longer by just taking it for 3 days. The effects of marijuana are gone within one day. But it's illegal. Instead this thing can do much more damage and it's legal. Why?

 

[Yamato]

rand() function statistical tests on drawdown

Been doing some tests on excel, of which I'll attach an example workbook:
View attachment rand_function_tests.xls

Here's what I found out for myself, because I didn't think of it before.

I have about 8 trades per day, but I am approaching it a little at a time.

If I had 2 trades per day, randomly distributed (which is not likely, because the tendency is for systems to lose together more often than randomly), and each trade had an edge of 90% wins, then the probability of having two losers in one day would be 1 in 100.

That means two losing days in a year, on average.

All other days would either be break-even or winning days.

Now this doesn't exclude that I might have 100 losing days in a row, but it's unlikely. But how unlikely? I don't know. Too complicated for now.

Let me just worry about what's likely.

Now, if the days were 3, and the edge 90%, what would happen?

I would think this would happen: with that edge, 1 trade loses 10% of the time. 2 trades lose 1% of the time, so 3 trades lose simultaneously 0.1% of the time.

But I want to avoid a negative day, so I can't do this. I want to know, how often 2 lose out of 3. This is much harder for my little brain, so I'll just list the % values, without worrying to predict what they will be.

I have extended the sample to 10,000 days, with always 3 trades.

I will attach the new sheet:
View attachment rand_function_drawdown_tests.xls

Ok, so now we can definitely say that 3 out of 3 lose 0.1% of the time.

With this powerful tool, we can do much more and much better: 30 thousands trades made each time, instantly.

Three trades per day, 10 thousand days.

Now, how often would I have 2 losing trades? 2.6% of the time, roughly.

How many days with one losing trade? With a 90% wins edge, 10% of losing on each trade... I would say 30% right off the bat. But it says 25%.

I won't try to reason about it. The point is to make money, not to be a professor.

I want to bring this thing closer to my present systems. Let's now bring the trades to 4 and see what happens.

Damn. Now I have to use "array-entered" formulas:
http://pubs.logicalexpressions.com/Pub0009/LPMArticle.asp?ID=103

Attaching it again:
View attachment rand_function_drawdown_tests_array_formula.xls

If I have an edge of 90% wins, and make 4 trades per day, I will need 3 negative trades to have an unprofitable day, and that will happen 0.5% of the time, roughly.

You see, there's a pattern here.

It doesn't matter that all systems have the same edge. If I use one system, I make 1 trade, and I have 10% chance of being unprofitable. If I use two systems, I make 2 trades per day, and I have 1% chance of being unprofitable. With 3 trades/systems, it actually increases, probably because it's an even number. But I am not here to reason, just to find out percentages.

Let's bring the number to my 8 trades and see what happens. Of course I've done similar stuff before but since I took xanax I forgot about it so I have to do it all over again now.

I get 0.05%, which, unless I made mistakes, is the probability of me having an unprofitable day, if I trade 8 times a day with an edge of 90% wins.

So this definitely shows that the more systems and markets traded, the better. No point in worrying about different things in money management. The number one concern should always be to create as many systems as possible.

Now that the number of trades is realistic, let's bring things even closer to reality, and decrease my edge, gradually to 66%, which is the real thing, as I am adapting it, considering I have bigger wins than losses.

I am attaching it one last time, because I've made it even better.
View attachment rand_function_drawdown_tests_array_formula.xls

But this means that even the file above got changed (the one before this one), because it had the same name and it got replaced.

So anyway, this is just perfect. Here are the results of my 8 daily trades with different edges and pretending there's a random distribution in wins and losses, which is not reality because they tend to stick together more often than randomly.

These are the probabilities of having an unprofitable day (with losses) according to my % of wins:

1) 95% gives me pretty much 0.00% losing days
2) 90% gives me 0.03%
3) 85% gives me 0.3% - holy cow it goes really fast, with such a little change in edge.
4) 80% gives me 1% - this means I'll have 2 losing day per year

Small interruption: these 8 trades must use a tiny fraction of my capital, or if each trade invests the whole capital things will change obviously, because say you lose everything on it, you can't trade anymore. So in other words capital cannot be affected by the outcome of each trade.

5) 75% of wins gives me about 3% of losing days, which is the same as saying that any given day will have a 3% chance of being unprofitable
6) 70% of wins gives me a 6% of losing days.
7) 65%, which is my situation, gives me a bit over 10% of losing days.

So we're back to that 10%, but earlier we got 10% with a 90% edge and 1 daily trade. Now we get 10% of losing days with a much smaller edge, 65%. This does not mean that more systems make more money. That 90% edge might actually make more money than all these systems. But I will not fear negative days. I will not fear my system going wrong.

Now of course I do not have these figures in my trading, because:

1) real losses tend to stick together
2) my systems are trading more capital depending on the contract and have bigger losses, so it's not really like having 8 daily trades but more like 4, because just one loss on the CL can make my day negative, even with wins everywhere else.

In this sense my trading will improve much when my capital will be enough to trade equal amounts of money for all futures and systems. This has to be explained better.

Say I have a CL system which is great, but it requires a larger margin and implies larger losses. What do I do, not trade it? I'll still trade it, and take a risk by doing that, but my other systems, requiring less margin, will not be allowed to take those risks, because it's not necessary and because I can't afford the margin (nor the risk) to double all contracts on all of them.

This makes me wonder if I am doing it right after all.

If you have a very good system like the CL, but you're overexposed by trading it, would it be better to:

1) forgo diversification and not invest on the CL which overexposes you even though it's the best?
2) overexpose yourself on the others as well, by trading 2 contracts and yet making diversification perfect and balanced?
3) only invest on your best system and forget about the smaller ones because they'd be better but have a lower edge?

As we've seen above, several systems (generating several daily trades) with a lower edge guarantee a smaller drawdown (but not overall profit) than one system (with one daily trade) with a better edge.

And I want first of all to worry about my drawdown, and the real reason is that it could be exceeded and therefore and I'd blow out my account.

If you think about it, that's why everyone worries about drawdown. If you were dead sure that your drawdown never gets exceeded, you would just bet the farm on your best system and let it trade alone. I would even quit my job immediately.

But we don't quit the job, because our job is like a system that makes little money but is almost guaranteed (banking job in Italy) to never have any drawdown. The monthly salary will always be there.

So, to get back to my 3 questions on what I should, here's how I answered them:

1) I didn't forgo my best system and still traded it despite causing me a bigger risk in terms of investment, and I did so, because it's a better system. Had its edge been the same, I wouldn't have traded it for now.
2) I am not overexposing myself on the other systems, because they have a lower edge, and it would not mean balancing anything out, because I'd be allocating the same capital to systems that don't perform as well.
3) I don't only invest on my best system, because some diversification is useful, even if you're diversifying on systems that are worse. Because together, they will guarantee profitability more than if I didn't use them. Their wins could pay for...

I don't know if it all makes sense but I am partly going by instinct about this, which means I am (unconsciously) reasoning but not well enough to be able to explain it.

To end this thing for now, I will see if the 65% wins edge of above that causes a 10% of losing days is reflected in my real losing days during the last 9 months of forward testing, keeping in mind all the many differences, also the fact that sometimes the systems traded 4 times a day, and other times 10 times a day.

Ok, done. I am attaching this as well (see bottom).


It says that my real systems lose 1 day out of 3, probably for the many reasons I mentioned above. So, I've got to be expecting it any time soon, because I haven't lost in a few days. I ever hope to have as few as 10% of losing days, I better start working on more systems.

And, in order to get results as random as possible ("random" meant in a positive sense), I would have to trade markets as diverse and unrelated as possible.

Another interesting thing I noticed is this: even a systems that had no edge, such a tossing a coin (excluding commissions and spread costs), would have a minority of unprofitable days as long as with 8 trades per day at least, or rather, with an even number of trades per day.

Here's my experiment with 8 trades per day:
0 negative trades 0.4 % days
1 negative trades 3 % days
2 negative trades 11 % days
3 negative trades 22 % days
4 negative trades 27 % days
5 negative trades 22 % days
6 negative trades 11 % days
7 negative trades 3 % days
8 negative trades 0.4 % days

To have a negative day, you need at least 5 negative trades (otherwise it's break-even or profitable), and that happens about 36.5% of the time.

Because that's really the bottom line, the even number or rather... If you have a 50% of wins, like tossing a coin, and you have one trade per day, you will have 50% of unprofitable days. But if you have 2 trades per day, you will have half as many, because you'd need to unprofitable trades in a row to have a losing day, and that has only 25% chance of happening.

I am reinventing the wheel and not so well, as usual. Instead of studying this stuff, I am discovering it, because this is the way I like it.

Let's see. With one trade per day or one coin toss, we'd have 50% of winning days, and they would be entirely profitable, while the other 50% would be entirely unprofitable. With 2 trades, we'd have 25% of all losing days, 25% of all winning, and 50% of break-even. This means no profit once again, but, incredibly (to me), we have a lower drawdown, because we only have 25% of unprofitable days. How can this be?

In one case we have a 50% of losing days, and in the other case we have a 25% of losing days, but the outcome is always zero. Xanax has really made me more stupid than I was.

Or statistics can drive you crazy. Or i am stupid. Or both.

The laws of probability are driving me crazy.

Anyway, with one toss 50%, with two only 25%, but guess what: with 4 it goes up again, to 31%. With 8 tosses it goes to 36.5%. I think this thing is going to 50% if you increase the daily tosses enough.

That's it, I am quitting now, because my brain can't take any more of this. Unlike Larry Hite, on bottom, I can't say I have a very good idea of what will happen over the long run. I need to take a math course, but not a course, I want to find a book for children, that makes me like it, because I am prejudiced against it.

God damn xanax. I thought drugs were fun to experiment with, but if I have to risk becoming more stupid than I am, then the hell with all drugs. **** marijuana as well. I want to understand statistics and keep my life under control. Don't **** with your own brain guys. Don't hurt yourself. I had to live this ordeal to realize it. 3 days of xanax have made me open my eyes. There will be no more pills, no more bad food, no more destroyers of my body...

 

[Adamus]

No, don't send me the pdf, I might spill coffee on it. Or absent mindedly tear a page out to roll up to snort my class A drugs with. Are you sure you're not manic depressive? You seem to go through similar cycles.

 

[Yamato]

What mental disorder do I have...?

I wish i knew what it was exactly. I once took a course in psychology, and I liked it a lot. I was reading about all the different illnesses and I thought I had each one of them. So I couldn't tell you exactly which one I have. I would definitely be quite sure that the one that I have the most of is the Narcissistic Personality Disorder (related to being "control freak"). Also, I don't know if being relaxed is a healthy state of mind, but certainly I am not a relaxed person. Certainly, I am not normal, but also, certainly, no one ever prescribed me any drugs. I never went to see any psychiatrist. I am not very social, but I am sociable. I avoid people because usually they bother me and I am used to being alone, but when I meet people I am quite friendly and know how to interact with them. I remember actually that in highschool and college I was often in big groups, and often - i hate to say this - I was the leader. I'd be the one who introduced people to one another, and decide what to do... but after a few months of this, I always got tired and quit the group, to their surprise. Even now, more antisocial than ever, I am the one getting people together and deciding what to do and when to do it. Simply because I can't have it otherwise (being "control freak"). So it's either my way, or I don't participate. So basically it's not that I am always the leader, but it's that I only participate when I am calling the shots.

 

[Yamato]

obsession with money management...

More thinking about one system vs several systems...

Say I have 100k.

Say I have a CL system, a very good one, that makes 100% a month based on the margin required, which is 5k. Actually I do have such a system, more or less.

But it has a drawdown of 5k, which could get as big as 10k, hypothetically. We hypothesize a max dd of 10k, twice as big, so Adamus is happy: "your largest loss is always going to be in the future (unless you plan to quit tomorrow)".

So can I invest all my capital on it?

If I invested 100k, the system would trade 20 CL contracts, and it would make 5k times 20 per month, which is 100k, which is obviously 100%. Pretty good, but I can't do it, because in the one month out of a year in which it incurs a drawdown (in our hypothesis 10k per contract), it would lose 200k. This if it happened at the start, because of course if happened after a year, we'd have millions, but I'd still blow out my account.

Basically we have a great system, which could blow out my account any time, due to a mistake in money management.

So, unless I have a system which always wins, what fraction of my capital can I invest on my hypothetical CL system and others?

Forget all the Optimal F and other similar formulas. I have figured out my own simple formula: I can invest only so much that if the drawdown happens, I can still trade the system in the same number of contracts.

So, for each contract I need the margin of 5k, plus a 10k of safety capital, like a buffer zone. So I can trade 1 contract every 15k I have. On this we have no doubts.

With 100k, I can therefore trade 100k divided by 15k, which is equal to about 6 contracts. But this will only take up a capital of 30k. What do I do with the rest of the money?

This is where my multiple systems step in.

Now, in my own sick hypothesis, since all drawdowns will not happen simultaneously, I can use up the remaining 70k, which is considered "safety capital", "buffer capital" for the CL system, as margin for more systems, but can i really do that?

No formulas really help me with this. No formulas that I read of.

If I traded each system separately, I could never do this. This if I wanted to be extremely safe.

That 100k would all be used up just for the CL. And my return on that CL contract would not be 100% a month, but just 5k times 6 = 30k, equal to 30% a month.

Then I'd need more capital to trade all the other systems.

But what I am doing instead is this: I am assuming that all systems will not lose at once.

And I am using the CL's 70k safety capital to trade other systems.

This way, on the CL I make 30%, because I can't make any more, for safety reasons. But i am not really caring about safety when I use the CL's capital to invest it on other systems, and make a combined 100%.

I bet it is indeed safer than investing the whole 100k on just the CL, but can we really discard that drawdowns won't happen all at once? How much can we discard this?

I would say, if we had 1000 systems on 1000 different securities, then we could discard it completely. But I am discarding that hypothesis completely with just 40 systems on 9 securities.

So... I am puzzled. However, the teaching is: since you cannot have one very good system with a small drawdown (let alone no drawdown, in fantasy land), and you can't invest all your capital on it, you're better off having as many systems with a lower edge as possible, and invest your whole capital but on all of them together (not all your capital on one), hoping their drawdowns won't all happen at the same time.

Yet, as I said, the optimization, through formulas, of the exact allocation of capital is something that escapes me. The only thing that's pretty clear is that the more systems/securities I am trading the safer it is to use up all my capital on these futures. And, once I do that and all my capital is invested, what other maximization of profits formula is there to worry about? If you're diversified enough to be safe by investing your entire capital on a bunch of systems/futures, you really are done working your ass off.

 

[Yamato]

disappointed by balsara pedantic academic as well

This book which we were talking about with Adamus, the one by balsara on money management. This book is no good either.

He is into academics like most other book writers.

Can't you just get to the point, give me your favorite money management formula and explain it as clearly as possible?

No, first he spends 90% of the book talking about anything but money management. Then in the one chapter on money management, he has to tell us about 10 different formulas according to 10 different theories, and he dedicates 2 pages to whatever seems to be his favorite theory, and doesn't even explain it clearly. What the **** is a point of calling your book with a money management title? Why don't you call it instead "Showing off my knowledge without helping anyone"?

These academic mother ****ers.

Forget Balsara and all other mother ****ing academic money management book writers. They're not even worth being downloaded for free on emule.