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Money Management Theory

  • #61
  • Oct 14, 2020 5:57pm Oct 14, 2020 5:57pm
Hey All,

Been gone for awhile but I'm back. BUMPing the thread. Money Management is just as important as ever. Always build a mm strategy into your trading strategy.

See you soon.

- Ric
Be humble or get humbled
  • #62
  • Oct 14, 2020 8:38pm Oct 14, 2020 8:38pm
Quoting LDFX
Money management is like the house’s foundation, without it nothing holds.
I agree 100% LDFX and thank you Riclater211 for initiating this important thread. Regarding my MM rules I democratically risk 0.3% of my actual equity on every trade, preferably 3 units of 0.1% each. I am a swing trader basing my signals on daily breakouts and planning to be in the trade usually from a couple of hours to a couple of days. Placing a trade I assume the breakout to work right away, this is the reason I trail aggressively my last unit based on hourly action, while I trail the core position(2 units) based on hourly channels. My trading philosophy is to maximize the winner first and to a lesser degree the number of them.
Keep alive a genuine winning attitude
  • #63
  • Oct 16, 2020 9:07am Oct 16, 2020 9:07am
After years of trading I'm sure that money management is the most important thing in trading and without a proper money management, any system can fail.
  • #64
  • Oct 17, 2020 4:05am Oct 17, 2020 4:05am
I'm not a professional trader, here's only an opinion of mine (I would like to be disproven).
Money management is just what keep the strategy profitable. If you have the best money management in the world and a crap system with <20% winrate you are not a professional trader (my opinion again).
If you have a good strategy that provides >70% win rate, decent R:R and the most basic level of money management, such as risk only 1% per trade, you are a professional trader.

One have the best money management, the other have the best strategy... On who are you going to bet?
There is no try
  • #65
  • Oct 22, 2020 1:37am Oct 22, 2020 1:37am
Quoting Wise-Jedi
I'm not a professional trader, here's only an opinion of mine (I would like to be disproven). Money management is just what keep the strategy profitable. If you have the best money management in the world and a crap system with <20% winrate you are not a professional trader (my opinion again). If you have a good strategy that provides >70% win rate, decent R:R and the most basic level of money management, such as risk only 1% per trade, you are a professional trader. One have the best money management, the other have the best strategy... On who...
Hello Wise-Jedi & thank you for posting,

I bet on money management.

Let me suggest 1st you stay away and get out of your mind the notion of win percentages. Win % is completely useless. If I lose 1 pip 99 times and win 1000 pips once, I have 1% win rate and I would be more successful than 95% of traders.

Look at money management as the financing/accounting department of your Forex business. Managing your trade is sales and marketing. 2 separate beasts.

Calculating margin, stop, margin requirements, pip value, commission, NAV with any other open trades need to be taken care of before a trade is executed.

Managing the trade is just that. Moving stops and setting your targets and realizing that it is OK to move your TPs down and that it is OK to close early. Trade management is different than money management.

You said, "Money management is just what keep the strategy profitable". I would argue that money management is to keep your losses low and keep your Forex business alive.

- Ric
Be humble or get humbled
  • #66
  • Oct 22, 2020 4:12am Oct 22, 2020 4:12am
I find agreement with you, but on only partially. The concept of "doesn't matter how frequently you win as long as you wins are bigger than your losses" seems logical in theory but in real situation it has its fault.

As you suggest: winrate 1% , win= 1000 pips, loss= 10 pip . So at the end of the day I should be breakeven, or in profit of 100 pip. But...

What if I miss that 100 pips trade? According to stat, now I have to wait about other 99 trades in other to get it. What if I got into a big drawdown and I can't stand one more loss. Can you be a professional trader with ~99 loss in a row? I don't think, where's the edge?

How about focusing on 2 things? Having a dynamic stop and finding an edge that provides me some more winrate. Now a loss is not 10 pips but ≤10 pips, combine this with a more frequent winrate (and of course a positive R:R) and you find two benefits: the first is that you win more consistently and the second is that you don't have to put on yourself all that psychological pressure.
There is no try
  • #67
  • Oct 26, 2020 6:38pm Oct 26, 2020 6:38pm
Quoting Wise-Jedi
I find agreement with you, but on only partially. The concept of "doesn't matter how frequently you win as long as you wins are bigger than your losses" seems logical in theory but in real situation it has its fault. As you suggest: winrate 1% , win= 1000 pips, loss= 10 pip . So at the end of the day I should be breakeven, or in profit of 100 pip. But... What if I miss that 100 pips trade? According to stat, now I have to wait about other 99 trades in other to get it. What if I got into a big drawdown and I can't stand one more loss. Can you be...
Hello,

Thanks for posting.

You are taking what I said, literally. Also i said 1 pip 99 times loss not 10 pip. Of course in realty that wont work since most will give up and move on before losing 99 in a row. My point was to show that win % is a non issue. I maintain it is a non issue. You seem to want to argue points that are plainly sarcastic and are only mentioned to prove a point.

Lets go over what you replied with.

As you suggest: winrate 1% , win= 1000 pips, loss= 10 pip . So at the end of the day I should be breakeven, or in profit of 100 pip

Your math was wrong, I said 1 pip not 10.

What if I miss that 100 pips trade? According to stat, now I have to wait about other 99 trades in other to get it. What if I got into a big drawdown and I can't stand one more loss. Can you be a professional trader with ~99 loss in a row? I don't think, where's the edge?

You are taking what I said literately. It was just an example of why you can't rely on win %. Only thing I rely on is net proft at years end. Why is it all the FX scams out there try and fool you with figures like pips gained, which is a number that does not matter, & % wins, a number that does not matter? I am not sure what the definition of a professional trader is except someone who works for a major firm. If you mean retail traders, I would argue you are either successfull retail trader or a failed one. Even then, what is successful is a matter of opinion.

How about focusing on 2 things? Having a dynamic stop and finding an edge that provides me some more winrate. Now a loss is not 10 pips but ≤10 pips, combine this with a more frequent winrate (and of course a positive R:R) and you find two benefits: the first is that you win more consistently and the second is that you don't have to put on yourself all that psychological pressure.

Finding a way to profit, as you call it an edge, is the whole point of trading. Dynamic stops work. I use them myself. R:R is also an over-hyped and over used term. It is fine to have a goal but any live trader will tell you, you are not always going to hit that R:R. My R:R is 3-1. I hit that number less than 25% of the time but it does equate to a good chunk of my profit each year. Most of my trades end up between >1:1 <2:1 but >3:1. When a trade turns around, I end it. Profit is profit. The risk on trade is reduced to 0 once you BE and add in for commission, spread & finance costs. You keep using the term win. Forex is not a game. You don't win, you profit.

-Ric
Be humble or get humbled
  • #68
  • Oct 28, 2020 7:58pm Oct 28, 2020 7:58pm
Hello All,

Some colleagues and I had a discussion this weekend on Kelly Criterion Money Management which is popular in the high end of Equities and Bond trading. When it comes to money management, I am always listening and looking for new ways to implement better money control over both profit and loses.

If you do not know what Kelly Criterion Money Management is, you can read about it here: Kelly Criterion Money Management.

The discussion centered around if this method would work in Forex the same it does in equities and bonds?

If so, does how we trade matter? Meaning the style of trade.

The focus of the method is to help you with position size in a particular asset class under a specific set of trade rules.

The math goes like this:

K% = W — (1 — W) / R

K% = percentage of capital to put into a trade

W = Winning probability

R= Win/loss ratio

I decided to test the waters and get the basics down and see what Kelly came up with for me.

My risk per trade is between 0.5% and 1% depending on the pair. Pairs like GBP/USD and GBP/JPY need a bit more breathing room than say AUD/USD of USD/JPY. My position size is 2% of my total starting monthly balance, of course that is without margin.

Step one is take your last 60 trades

Calculate your winning probability by dividing profitable trades by all trades taken.

Last 60 Trades = 32 positive & 28 negative. 55% or 0.55

Next, calculate profit/loss ratio.

Average profit as a % of equity over last 60 trades = 0.073 or 0.73%

Average loss as a % of equity over last 60 trades = 0.03 or 0.3%

0.073 / 0.03 = 2.43

(2.43 x 0.55 - 0.45) /2.43 = 0.36 or 36%

According to the math I should risk 36% per position. Yeah. Not in this lifetime. Unless I did it wrong and someone out there can verify it with showing the work.

You will quickly find out that most folks who use this do so using something called Fractional Kelly. To me that is just arbitrary. You can find calculators and spreadsheets that us half Kelly, or even 1/3 Kelly. Even in equities, this type of position sizing is way to much. I'm not exactly sure how Mr Buffet and the rest use this but I do not see any positions in Berkshire Hathaway that look like that.

It may work for others, but as for me, no thanks. I am doing just fine with my current money management scheme.

Until next time.

- Ric
Be humble or get humbled
  • #69
  • Oct 28, 2020 8:15pm Oct 28, 2020 8:15pm
That's Kelly, it just shows theoretical maximum. For the record, if your system shows 55% win ratio and W/R is 2.43 meaning that on average your win is 2.43 larger than your loss, that's one helluwa system and no wonder that Kelly result is so high. What you would need is much larger sample than 60 trades to have it normalized.

Buffett doesn't trade, he invests.
  • #70
  • Oct 31, 2020 1:18am Oct 31, 2020 1:18am
Quoting mades
That's Kelly, it just shows theoretical maximum. For the record, if your system shows 55% win ratio and W/R is 2.43 meaning that on average your win is 2.43 larger than your loss, that's one helluwa system and no wonder that Kelly result is so high. What you would need is much larger sample than 60 trades to have it normalized. Buffett doesn't trade, he invests.
Hey mades,

Thanks for the reply.

I understand how Kelly works. The whole point of the exercise was to follow the rules set forth and see how it turns out for Forex trading. The rules stated to use the last 50-60 trades. I took the larger sample group of 60. I tested as is. There is no point to change it. Most profitable traders end up with high numbers and are forced to use fractional Kelly, which I mentioned above, so I am not surprised by the results.

In the book, Concentrated Investing: Strategies of the World's Greatest Concentrated Value Investors , Chapter 4 , Warren Buffett: The Kelly-Betting Value Investor, it is explained that Warren Does indeed use a Kelly variant. I never said he was a trader, I said he uses Kelly.

With all that corrected, my point was to ask if anyone else has tried to use it in their trading or if they tested it after reading this and came up with any different numbers and or if you think you would use it in your trading.

Thanks for stopping by.

- Ric
Be humble or get humbled
  • #71
  • Nov 10, 2020 11:56pm Nov 10, 2020 11:56pm
Modern Monetary Theory or Modern Money Theory (MMT) is a heterodox macroeconomic theory that describes the currency as a public monopoly and unemployment as evidence that a currency monopolist is overly restricting the supply of the financial assets needed to pay taxes and satisfy savings desires.
  • #72
  • Nov 11, 2020 1:39am Nov 11, 2020 1:39am
Hello, is money management is as important as risk management? Is it a method that guarantees profitable results?
  • #73
  • Edited 2:13am Nov 11, 2020 1:55am | Edited 2:13am
Quoting riclater211
Kelly Criterion
Step one is take your last 60 trades Calculate your winning probability by dividing profitable trades by all trades taken. Last 60 Trades = 32 positive & 28 negative.
55% or 0.55

Hi Ric,

We used to use Kelly variations in horseracing gambling (back in the day, 1980's lol).

Transferring that same criteria to modern day FX I came up with the following

In your scenario with a 55% win rate (0.55),

and assuming the outcome (odds) of your next trade was Even Money (1/1) meaning the SAME TP as SL.
(ie price will either go up or down to trigger your TP or SL)

Then your Kelly bet in that instance would be .... 10% of your a/c

You should then consider margin as well I guess, once a losing trade occurs (though you do recalculate & base your risk against the new a/c level each time).

Not for me but good fortunes.

--------------------------------------------

(edit)
- found a site that has the calculator (and formula)

http://www.bettingtools.co.uk/kelly-calculator

in this case the odds would be entered as 2
(which is 1/1 conventional and a 2.0 return decimal) (commission=0 unless you want to factor in spread & broker commish as well to finesse)
  • #74
  • Nov 11, 2020 6:10am Nov 11, 2020 6:10am
In my whole trading experience, I have realized that risk management is the most important thing that you should learn.
  • #75
  • Nov 14, 2020 12:00am Nov 14, 2020 12:00am
Quoting steavenrover
Modern Monetary Theory or Modern Money Theory (MMT) is a heterodox macroeconomic theory that describes the currency as a public monopoly and unemployment as evidence that a currency monopolist is overly restricting the supply of the financial assets needed to pay taxes and satisfy savings desires.
Hello steavenrover.

Than you for the copy paste of for the definition of Modern Money Theory. However, can I ask you what is the point of that? Can you explain what you meant by posting that?

Thanks,

- Ric
Be humble or get humbled
  • #76
  • Nov 14, 2020 12:09am Nov 14, 2020 12:09am
Quoting Akwin
Hello, is money management is as important as risk management? Is it a method that guarantees profitable results?
Hello Akwin,

It means the same thing. It is the most important aspect of trading and should always be worked in to your trading style.

- Ric
Be humble or get humbled
  • #77
  • Nov 14, 2020 12:14am Nov 14, 2020 12:14am
Quoting TimeTells
{quote} Hi Ric, We used to use Kelly variations in horseracing gambling (back in the day, 1980's lol). Transferring that same criteria to modern day FX I came up with the following In your scenario with a 55% win rate (0.55), and assuming the outcome (odds) of your next trade was Even Money (1/1) meaning the SAME TP as SL. (ie price will either go up or down to trigger your TP or SL) Then your Kelly bet in that instance would be .... 10% of your a/c You should then consider margin as well I guess, once a losing trade occurs (though you do recalculate...
Hey TimeTells,

Thanks for posting.

Most people I came across did use it in the past but not now and most also used it for gambling over trading and investing. I did not much care for it either. After testing, it does not work for me and my trading style. Thanks for your input.

- Ric
Be humble or get humbled
  • #78
  • Nov 14, 2020 12:19am Nov 14, 2020 12:19am
Quoting joeerickson
In my whole trading experience, I have realized that risk management is the most important thing that you should learn.
Hello joeerickson,

I am glad to hear it. I wish more people would take it seriously. Most people who get into this business have no idea about how much it costs to trade, how to properly size trades based on account size or any of the important things in running this business. Everyone is busy looking for the "HOLY GRAIL", which does not exist.

- Ric
Be humble or get humbled
  • #79
  • Nov 14, 2020 12:59am Nov 14, 2020 12:59am
there is no golden rule in money management, but money management must adapt to the hit rate of the strategy used.
  • #80
  • Nov 14, 2020 1:57am Nov 14, 2020 1:57am
Money management should be adaptative to the volatility of the market.
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