Bakwaas Trading

augubhai

Well-Known Member
System Hopping

System Hopping
* Re-pollinating what I posted on my blog on 5th November

I change my trading methodology frequently. I was doing discretionary trading in the October series. Now, I am trading the November series mechanically.

Whenever I trade a system, I hope that it will work out well, and for a long time. But soon, I get disillusioned and change my trading method.... mostly because of a losing streak, but many times simply because I don't like system behavior in further back tests and scenario tests.

At this point, I really don't care about the systems, as long as certain criteria are met. And the criteria itself is not well defined. However, from the top my head....

  1. Profitable
  2. High rate of growth of capital
  3. Small drawdowns
  4. Peace of mind/Less screen time

As long as I make money, hopefully fast and with low risk...

I have posted thoughts related to criteria in my Bakwaas Trading thread on Traderji.

 

augubhai

Well-Known Member
The plan...

This is the problem which every new trader has to face. What % to reinvest depends on whether one is in capital building stage or capital preservation stage. In capital building stage of a new trader his capital is small, household expenses and housing loan installments take away major chunk of the profits leaving very little for capital formation. This happens with every new trader. It happened with me too and the capital formation is slow. But one should invest back 50 % of the profits in capital formation stage. Once capital acquires a critical mass, then the profits increase rapidly and our expenses dont increase in the same proportion and then the capital formation process becomes faster.

In capital preservation stage all financial needs, present and future , are met and the trader trades not for making more money but he trades because he enjoys it and that gives him occupation and income apart from fulfilling his passion. In this stage money ,though important, assumes lower priority. In that case he may take out all 100 % of profits and invest it elsewhere.

I too used to have same questions when I was in capital formation stage, I was into trading full time, no other income source,no inheritance in terms of money, and household expenses and HDFC housing loan installments to be met from trading income....but after a few years the capital grows in exponential proportion....so just concentrate on trading well and making consistant profits...all other things will fall in place .

Smart_trade
 

augubhai

Well-Known Member
Kelly Criterion

Kelly Criterion

Code:
[B][SIZE="5"][FONT="Verdana"][COLOR="Red"]f = ( p * ( b + 1 ) -1 ) / b[/COLOR][/SIZE][/B]


where,
f = optimal fraction of capital to be risked to maximize long term gain
p = probability of winning (Win %)
b = expected reward per unit of risk (Risk Reward Ratio)[/FONT]

As long as you know your p and b, risk f.


.
 

TracerBullet

Well-Known Member
Re: Kelly Criterion

Kelly Criterion

Code:
[B][SIZE="5"][FONT="Verdana"][COLOR="Red"]f = ( p * ( b + 1 ) -1 ) / b[/COLOR][/SIZE][/B]


where,
f = optimal fraction of capital to be risked to maximize long term gain
p = probability of winning (Win %)
b = expected reward per unit of risk (Risk Reward Ratio)[/FONT]

As long as you know your p and b, risk f.

.
As per a book i am reading, Kelly criteria is maybe too aggressive for trading, 1-2% may be safer once you have an edge. If you are still not profitable, better keep minimum qty.
 

augubhai

Well-Known Member
Re: Kelly Criterion

As per a book i am reading, Kelly criteria is maybe too aggressive for trading, 1-2% may be safer once you have an edge. If you are still not profitable, better keep minimum qty.
The problem is that we are unsure of the future win % and RR ratio of trading systems. I guess that is the reason most books recommend 1-2% risk.

For example, if a system has a Win % of 50% and RR ratio of 1.6, then the optimal risk is 18.75% of compounded capital on every trade.

- If we risk 19% per trade, then after 100 trades, the capital will be 15.42 times the initial capital (1442% return on capital)
- If we risk 18% per trade, then after 100 trades, the capital will be 15.36 times the initial capital
- If we risk 15% per trade, then after 100 trades, the capital will be 13.87 times the initial capital
- If we risk 10% per trade, then after 100 trades, the capital will be 8.61 times the initial capital
- If we risk 5% per trade, then after 100 trades, the capital will be 3.61 times the initial capital
- If we risk 2% per trade, then after 100 trades, the capital will be 1.76 times the initial capital (76% return on capital - not too bad)
- If we risk 1% per trade, then after 100 trades, the capital will be 1.34 times the initial capital (34% return on capital)


The return with 19% risk looks grand... but there could be practical difficulties.

1. Will the Win % and RR ratio of the system hold into the future?
2. What happens when the system hits a continuous losing streak? According to calculations, we should still continue to risk the optimal risk %, if the system will get back to the Win % and RR ratio in future.
3. Margin requirements may limit position size, and not allow optimal risk.
4. The market/s may not have sufficient liquidity to allow compounding of position size.
5. With increased position size, slippages and fills may be affected. This will also impact the Win %, RR ratio, and % of Capital risked.

Questions 4 and 5 only become relevant when the position size increases significantly. For a small trader, only question 1 to 3 are relevant, and the answer is that we should try to risk close to the optimal risk to get better return on capital.
 

augubhai

Well-Known Member
Re: Kelly Criterion

The problem is that we are unsure of the future win % and RR ratio of trading systems. I guess that is the reason most books recommend 1-2% risk.

For example, if a system has a Win % of 50% and RR ratio of 1.6, then the optimal risk is 18.75% of compounded capital on every trade.

- If we risk 19% per trade, then after 100 trades, the capital will be 15.42 times the initial capital (1442% return on capital)
- If we risk 18% per trade, then after 100 trades, the capital will be 15.36 times the initial capital
- If we risk 15% per trade, then after 100 trades, the capital will be 13.87 times the initial capital
- If we risk 10% per trade, then after 100 trades, the capital will be 8.61 times the initial capital
- If we risk 5% per trade, then after 100 trades, the capital will be 3.61 times the initial capital
- If we risk 2% per trade, then after 100 trades, the capital will be 1.76 times the initial capital (76% return on capital - not too bad)
- If we risk 1% per trade, then after 100 trades, the capital will be 1.34 times the initial capital (34% return on capital)


The return with 19% risk looks grand... but there could be practical difficulties.

1. Will the Win % and RR ratio of the system hold into the future?
2. What happens when the system hits a continuous losing streak? According to calculations, we should still continue to risk the optimal risk %, if the system will get back to the Win % and RR ratio in future.
3. Margin requirements may limit position size, and not allow optimal risk.
4. The market/s may not have sufficient liquidity to allow compounding of position size.
5. With increased position size, slippages and fills may be affected. This will also impact the Win %, RR ratio, and % of Capital risked.

Questions 4 and 5 only become relevant when the position size increases significantly. For a small trader, only question 1 to 3 are relevant, and the answer is that we should try to risk close to the optimal risk to get better return on capital.
Oh, I forgot to mention what happens when we increase the risk beyond the optimal %.

For the same parameters as above,

- If we risk 20% per trade, then after 100 trades, the expectancy is that capital would be 15.25 times the initial capital
- If we risk 25% per trade, then after 100 trades, the expectancy is that capital would be 11.47 times the initial capital
- If we risk 30% per trade, then after 100 trades, the expectancy is that capital would be 5.86 times the initial capital
- If we risk 40% per trade, then after 100 trades, the expectancy is that capital would be 0.45 times the initial capital (55% loss of capital)
- If we risk 50% per trade, then after 100 trades, the expectancy is that capital would be 0.01 times the initial capital (99% loss of capital)
- Risk above 50%, then after 100 trades or lesser, and have the expectancy of losing 100% of your capital!!
 

TracerBullet

Well-Known Member
Re: Kelly Criterion

The problem is that we are unsure of the future win % and RR ratio of trading systems. I guess that is the reason most books recommend 1-2% risk.

For example, if a system has a Win % of 50% and RR ratio of 1.6, then the optimal risk is 18.75% of compounded capital on every trade.

- If we risk 19% per trade, then after 100 trades, the capital will be 15.42 times the initial capital (1442% return on capital)
- If we risk 18% per trade, then after 100 trades, the capital will be 15.36 times the initial capital
- If we risk 15% per trade, then after 100 trades, the capital will be 13.87 times the initial capital
- If we risk 10% per trade, then after 100 trades, the capital will be 8.61 times the initial capital
- If we risk 5% per trade, then after 100 trades, the capital will be 3.61 times the initial capital
- If we risk 2% per trade, then after 100 trades, the capital will be 1.76 times the initial capital (76% return on capital - not too bad)
- If we risk 1% per trade, then after 100 trades, the capital will be 1.34 times the initial capital (34% return on capital)


The return with 19% risk looks grand... but there could be practical difficulties.

1. Will the Win % and RR ratio of the system hold into the future?
2. What happens when the system hits a continuous losing streak? According to calculations, we should still continue to risk the optimal risk %, if the system will get back to the Win % and RR ratio in future.
3. Margin requirements may limit position size, and not allow optimal risk.
4. The market/s may not have sufficient liquidity to allow compounding of position size.
5. With increased position size, slippages and fills may be affected. This will also impact the Win %, RR ratio, and % of Capital risked.

Questions 4 and 5 only become relevant when the position size increases significantly. For a small trader, only question 1 to 3 are relevant, and the answer is that we should try to risk close to the optimal risk to get better return on capital.
But markets can go in different phases and your expectancy could be different. A series of losses in trading range with 10% risk per trade will ruin the capital.

Anyway, small quote from the book, make sure you test your position sizing over large number of trades and also only use it once you have an actual verified edge.

Most optimized
approaches like this are extremely aggressive, and large drawdowns must be accepted
as a matter of course. In addition, and much more seriously, the theoretical assumptions
behind these models are important and they rarely hold up in short-term trading.

......

If you are going to use any of these approaches
in actual trading, make sure you understand the assumptions and the risks involved in
violating any of those assumptions.
And some blog posts - here and here

Anyway, good luck !
 
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