Money Management: Just Like Sex

黄河之水天上来

Money Management: Just Like Sex
MICHAEL COVEL (August 24, 2005)
So how much thought have you given to money management recently? Or are you still too preoccupied by all kinds of indicators or fundamental buy, sell and holds to focus on the subject?
Eventually, however, you've got to ask yourself the most important question of all: "how much?" right?
Getting a straight answer to that one may be tough. There's still a lot of confusion about risk or money management from so-called gurus. I recently saw the following comment regarding money management from a "guru":
"[We] use very simple money management: Trade one contract per trading signal in the markets … with no pyramiding."
This is NOT money management. When you hear someone describe money management like this trading guru, run don't walk the other direction as you are about to be conned.
So if money management isn't some set amount of shares or contracts picked out of thin air, what is it? Money management answers the question of "how much?" At all times, given the risk you are taking, the money you have, and the volatility of the market -- you must know the optimal number of shares or contracts to be long or short.
In my opinion money management or position sizing or bet sizing just doesn't get the attention it deserves. Gibbons Burke of MarketHistory.com observes:
"Money management is like sex. Everyone does it one way or another, but not many like to talk about it and some do it better than others. But there's a big difference: Sex sites on the Web proliferate, while sites devoted to the art and science of money management are somewhat difficult to find."
Money management is ultimately a defensive concept. It keeps you in the game. For example, money management tells you whether you have enough new money to trade additional positions. Trend followers all realize that you need to make small bets initially to simply stay alive and play another day. So, if you start at $100,000, and you're going to risk 2 percent, that will be $2,000. You say to yourself, "Why am I only risking $2,000. That's nothing compared to what I've got to bet." But that's not the point. First things first. You can't predict where the trend is going to go, so you can't afford to risk all of your capital out of the gate. Trend follower Craig Pauley points out:
"There are traders who are unwilling to risk more than 1% but I would find it surprising to hear of any trader who risks more than 5% of assets per trace. Bear in mind that risking too little doesn't give the market the opportunity to allow your profitable trade to occur."
Think about money management as you would about getting into physical shape. You can't lift weights six times a day for hours each day for 30 straight days without hurting yourself. There's an optimum amount of lifting you can do per day that gets you ahead without setting you back. You want to be at that optimal point just as you want to get to an optimal point with money management. Trend follower, Ed Seykota, author of The Trading Tribe book, describes this optimal point with his concept of "heat".
"Placing a trade with a predetermined stop-loss point can be compared to placing a bet. The more money risked, the larger the bet. Conservative betting produces conservative performance, while bold betting leads to spectacular ruin. A bold trader placing large bets feels pressure - or heat - from the volatility of the portfolio. A hot portfolio keeps more at risk than does a cold one. In portfolio management, we call the distributed bet size the heat of the portfolio."
Trading correctly is 90% money management, a fact that most people want to avoid or don't understand. However once you have money management down, your personal psychology will be 100% of your trading success. Once you have the rules, you still need to follow them!
Why then do traders have such trouble keeping their trading proportional? Why is it so hard for them to find that optimal point? Fear. Trend follower Tom Basso points out that traders usually begin trading small and then as they get more confident increase their trading size. Once they get to a certain comfort level of say, 1000 contracts, they often stay there, suddenly fearful that turning up the "heat", to use Seykota's term, will increase their risk. For trend followers like Basso, the goal is to keep things on constant leverage.
Few traders make the move to a proactive posture in which risks are actively managed for a more efficient use of capital. How do you avoid trading less instead of trading the optimal amount at whatever capital you have? You need to create an abstract money world. Don't think about what money can buy. Just look at the numbers like you would when playing a board game like monopoly or risk.
And since your capital is always changing, it's important to continually rebalance your portfolio. Trend follower Paul Mulvaney points out that, "Trend following is implicitly clear about dynamic re-balancing which is why I think successful traders appear to be fearless. Many hedge fund methodologies make risk management a separate endeavor. In Trend Following it is part of the internal logic of the investment process."
There it is: the key is a risk understanding. That's what money management is really all about. Managing risk.

黄河之水天上来

Money Management, Bet Sizing, Position Sizing All Mean the Same Thing
Michael Covel (February 15, 2005)
The class of those who have the ability to think their own thoughts is separated by an unbridgeable gulf from the class of those who cannot.
Ludwig von Mises

Money Management has many names: asset allocation, position sizing, bet size, portfolio heat, portfolio allocation or even risk control. It is terribly important for long term success. It is at the root of all trend following winners.

Q. Why exactly is money management so important?
A. Determining your bet size is key. If you don't know how much to buy or sell (your bets) at all times you are in trouble. If you start with $10,000...is your first trade 2% of that? 10%? What is the number? You must know it.

Q. What do you mean?
A. Most traders believe that money management is simply where you place your stop. A stop alone is one part of a trading system, it's not money management. You can buy any number of programmed systems for TradeStation (we don't recommend TS) that all tell you they have money management built in, but all they really do is give you a stop. The key question of money management must focus on the "how much" question, not the timing of when you enter or exit. Worry about the optimal amount to trade or how much to buy or sell -- those are the key questions for all traders.

Q. Money management yeah whatever - I want to know about trading system percent accuracy. What is it?
A. You are on the road to the poor house! Percent accuracy is fools gold. System 1 below looks more impressive than System 2 if we use your focus on accuracy. 85% accurate, you can't go wrong right? Wrong:

System One

Percent Win: 85%

Percent Loss: 15%

Avg Profit: $500

Avg Loss: $1,500

Expectation per trade: $200
System Two

Percent Win: 45%

Percent Loss: 55%

Avg Profit: $1,500

Avg Loss: $500

Expectation per trade: $400



The examples above show how and why the desire to be right kills many traders. They focus on % winning trades and % losing trades instead of proper bet size (money management). System 2 is the better system. It makes more money. System 1 is all about ego (and long term losing). System 2 is all about math.

More on Accuracy Grails.

Q. Is there a prerequisite market condition for Trend Following to work?

A. Trend Following makes the most money in trending markets, but that is not something you can predict. It is a false notion that you can pick the trading approach for any one period of time. You would end up jumping around looking for the Holy Grail going from system to system. The idea of Trend Following is to make big money on big trends, but preserve capital and avoid losses in non-trending periods. Jump around and you are destined to lose.

Q. How would you apply Trend Following to a less developed stock market in the Far East where dissemination of price-sensitive information tends to be less efficient leading to irrational price movement?
A. People attempt this same argument here in the States. Why care what a market does? Trend Followers just follow along. And let us ask what is 'irrational' defined mathematically? Saying a market is 'irrational' hints at lack of an ability for you to predict it. No prediction is used with Trend Following.

黄河之水天上来

Know Your Breakeven for Trading Systems
Michael Covel (August 05, 2005)
Traders should be concerned about making money; after all it is the reason to be in the markets. In the beginning, most traders are concerned more about the total return of their investment rather than their exposure. However, stay in the game long enough and you will agree with the professionals - take care of the losers and the winners will take care of themselves.

When reviewing a trading system you should concern yourself with the breakeven level of your system. Or the minimum level of performance that will still show a profit. In plain language, "how often can you be wrong and still make money?"

Let's look at two different trading systems and see how they compare:

System #1
Percent Accurate: 65%
Average Win: $850
Average Loss: $1,100

System #2
Percent Accurate: 37%
Average Win: $3,400
Average Loss: $900

On the surface system one looks substantially better than system two. It is 65% accurate after all. Most traders can stomach being right 6 times in 10. System two with its 37% accurate would be hard to sit through - or so it seems.

When you look at expectation per trade you begin to see the big differences between the two systems. The expectation per trade measures the expected amount you will make on a given trade. This statistic uses a sample of the trades from a given track record.

System One expectation per trade: $167.50
System Two expectation per trade: $691.00

System one has a low expectation per trade. A little bit of slippage or transaction costs can eat of the majority of its expected profit. System two has a more robust expectation. Slippage and transaction costs will not decrease its expected profit as much as system one.

Looking at the breakeven percent shows an even bigger difference in the two systems:

System one breakeven percent: 56.4%
System two breakeven percent: 20.9%

System one must be right more than half of the time just to generate profits while system two can be right less than 25% of the time. With this information, which system would you rather trade?

Assume you begin trading each system, each takes 10 trades. Both systems loose the first 8 trades and the last two trades are profitable.

System One After 8 losers: (8 x $1,100) = ($8,800)
System Two After 8 losers: (8 x $900) = ($7,200)

System One Next 2 trades are winners: (2 x $850) = +$1,700
System Two Next 2 trades are winners: (2 x $3,400) = +$6,800

System One Net results of 10 trades: ($7,100)
System One Net results of 10 trades: ($400.00)

What happens if you begin trading either system and you hit a string of 8 losers? System one is down $8,800 and system two is down $7,200. What happens if the next two trades are winners? System one will be sitting at loss of $7,100 and system two will be at a loss of $400.00. The recovery time of system two is much better than the recovery time of system one.

Manage your breakeven percent and making money is easier. Do not be fooled into trading a particular trading system just because of a so-called high percent accuracy. At the end of the day, your gut will measure drawdown recovery and your mind will accept a lower accuracy.

黄河之水天上来

Being Right and Making Money Are Not Equivalent
Michael Covel (October 07, 2005)
Trading Wisdom from Van K. Tharp on "being right":

How important is it for you to be right? Let’s say I could guarantee that you would make money by the end of the year — lots of money — but you would probably lose money on 90% of your trades. Would you like that? Could you tolerate that? Would you accept that? Most people would probably answer "no" to all three questions. And if that is you, you probably are denying yourself the opportunity to make money simply because being right is more important than making money. Some of you might be saying, "How could you be wrong 90% of the time and still make money?" The solution goes back to the golden rule of trading, "Cut your losses short and let your profits run." Let’s say that 90% of your trades lose money and that your average loss is $100. On the year you make 100 trades so you end up losing 90 of them for a total loss of $9,000. However, let’s also say that your average winning trade is a big R-multiple. It’s an R-multiple of 100 or a $10,000 winner. You have ten of those in a year, so you end up making $100,000 on your winning trades. If you subtract your winnings from your losses, you’d end up with a profit of $91,000 at the end of the year. You make $91,000, yet 90% of your trades are losers. My guess is that 99% of the trading population could not trade a system that would produce those kind of results. The reason is because they don’t get to be right enough. They have too many losing streaks. They have losing streaks that are longer than five in a row. Most people cannot tolerate long losing streaks. When they occur, they totally abandon what they are doing. In such a system you could easily have 25 consecutive losses. At that point you become certain that your system is broken, and you try something else. Let’s look at the opposite end. Suppose you got to be right 90% of the time. Suppose your average win was $100 and that your average loss was $2,000. This means that you’d have a total of $9,000 in winnings and $20,000 in losses. You would lose $11,000. Would people trade that system? Yes, they would. They would probably trade it for a number of years until they went bankrupt. Why? Because they get to be right most of the time and that is very rewarding. You might be saying, but how could people possibly tolerate losses of $11,000 after 100 trades? It is easy, they turn the losing trade into a long term investment in their mind and say "it’s only a paper loss." For example, I’ve had workshop attendees who were probably way above average in terms of sophistication. However, I asked them to raise their hands if they had an investment in their portfolio that was only worth 50% or less of what they paid for it. Eleven people raised their hands—over a fourth of the class. And my guess is that among the overall population of investors, most people are sitting on a number of big losers, hoping they will come back. Why? Because they cannot stand to be wrong on an investment and they are waiting to be right on those losing trades. What is the cost of having losing investments in your portfolio? It’s major. First, you are using valuable capital up with nonproductive investments. Second, you are missing many good opportunities. There are two primary reasons why we focus on being right. First, we are conditioned to be right by the school system. Second, everyone in the trading industry gives people what they want – ways to be right – which tends to perpetuate the myth. Let’s take a closer look at these two reasons. First, we are conditioned by the school system to the importance of being right. In school you are taught that there are right answers and wrong answers. What is a right answer? If you learned how to survive in the system, you learned that a "right" answer is whatever the teacher wanted. Your performance is measured periodically through tests in which you are asked to pick the right answer. If you cannot get more than 70% right on the test, you are labeled a failure and ostracized. Your humiliation might even be in public in front on all your friends. And if your humiliation isn’t public, it certainly is semipublic. Your "poor" performance goes home in the form of a grade with a comment that "Johnny is a little slow or Johnny is bright, but he just doesn’t try." Usually, at this point, the most important people in your young life get involved - your parents. Even if you understand the system and work hard to know the right answers, you still might be taught that your performance is not good enough. It usually takes 94% right to get an excellent grade. But how many children go home and show their 94% test to Dad only to get the response, "Why didn’t you get 100%?" Thus, it is no wonder that traders want to be right all the time. And being right usually costs them dearly in terms of profits. Whether you’ve been through 20 years of schooling and have a graduate degree or less than 10 years of schooling, you still have the same conditioning about being right. The second reason people want to be right is that service providers for traders and investors feed the bias to be right. First, software vendors tend to provide systems that can be highly optimized. Once you’ve optimized your trading, you can lay a line over the prices and see exactly where you should have bought and sold. It seems obvious. However, the same optimized system does very poorly when applied to the real world. At investment conferences, the hottest speakers are those who provide information about high probability entry techniques. If you say "trade with the odds on your side" and show someone a technique that is right 75% of the time, you’ll get a large audience. Yet most techniques of this nature usually have big losers and may not even have a positive expectancy. Nevertheless, being right 75% of the time is all is takes to get people to trade them.
Van K. Tharp

limkky

好文章.让我面对现实.