So how do we choose?
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- Note the similar max drawdowns of fixed capital, Williams fixed risk, fixed percentage, and fixed volatility. This is a coincidence caused by limiting all strategies to a 100 contract maximum. These strategies all hit their largest dd at the 100 contract level.
- No ‘hard and fast’ rule for selecting the superior method
- However Penfold says we can do away with fixed risk because of its lower profit despite its lower std deviation, and highest net profit to dd ratio
- Fixed ratio had the lowest dd but Williams fixed risk was 5 percent worse dd with 8x the profit outcome, so it seems superior to fixed ratio
- However Williams fixed risk had std deviation of 6.3, twice that of fixed ratio
- Percentage dd only considers the risk side of the equation - not the reward
- An alternative is to measure dollar dd (risk) against dollar reward generated
- Look at net profit to $dd ratio or value payoffAttached Image
- Look at net profit to $dd ratio or value payoff
In fact, Penfold goes on a drawn out multi-variable analysis to determine which system reigns supreme, and while interesting, and possibly even useful, I won’t duplicate it here. I’ll just mention that he considers
- Speed to reach the contract limit
- Ability to handle catastrophic losses
- Value payoffs (net profit/dollar dd)
- The pro's choice (fixed percentage)
- Ability to withstand long streaks of losing
- Minimizing risk of ruin
- Removing the 100 contract cap
- Specific Profit objectives
- Individual trader needs (no one size fits all)
- Monte Carlo analysis
- Equity curve stability (use a system stop much like you use individual trade stops)
- Ultimately the best MM depends on too many factors that are dependent on the trader and the system being traded
- If you’re disappointed that I omitted this part, pick up the book. Probably, every trader should own this book anyway, it’s that good, no matter what comes next.
The two main takeaways every trader should get from this chapter is
- Obviously this is the most important (and longest) chapter in the book because this is the meat of profitable trading if you believe (as Penfold and I do) that the markets are mostly random. I say mostly, as I don’t think they’re entirely random; that would ironically, make things easier.
- The more time spent on this aspect of your strategy is likely not wasted time, yet most traders do this backwards, and that’s why they’re outside the ‘winner’s circle’.
Is this the final word on money management? I think after finishing the chapter you will realize there are other ways to get creative with this - for example hybrid techniques that could ‘ramp-up’ safely, but I guess the odds are at least one of these approaches will work with any system even without modifications.
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