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Strategies & Market Trends : Systems, Strategies and Resources for Trading Futures

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To: Patrick Slevin who wrote (12083)	1/9/1999 12:11:00 PM
From: Tom Trader	Read Replies (6) of 44573

Patrick, I am addressing this post to you because I think that you mentioned that you have an engineering background -- but the question is open to anyone who has a knowledge of statistics. It has to do with developing a formula for money management when trading futures -- and the number of contracts that one should trade at any point in time. I use a formula of sorts at this time but I think that it needs to be refined to achieve optimum results. What I am trying to achieve is a completely mechanical, conceptually sound approach to determining the number of contracts that should be traded at any point in time. I read something about this concept sometime back and it goes something like this: if one were to wager money on a horse and one knew with a total level of certainty that the horse would win the race, one would wager 100% of ones available funds. On the other hand if one were to know that there were absolutely no likelihood that the horse would win one would not wager any money on the horse. If the probability were something in between, the amount that one would wager would be adjusted accordingly -- and depending on the odds being offered the wager would be further adjusted. Now extend this concept to trading in futures: say that my system over a 10 year period produces 55% winning trades -- therefore 45% would be losers. Now take that a step further and say that the $win/loss ratio is about 3:1 -- meaning that for every dollar that I lose in a bad trade, I make $3 in a good trade. Further let us say that my average winning trade makes $1000 per contract and the average losing trade is $330 per contract. Finally, the highest winning trade is $10K per contract and the highest losing trade is $4K per contract. The question is: what percentage of my available capital should I be willing to invest in a trade? The basic premise of this approach is that the number of contracts that I trade at any point in time would be a function of my available capital--but it would need to be adjusted based on the statistical results that my system has achieved in the past. So as my trading capital increases/decreases the number of contracts that I trade would go up/down. But given the track record of the system -- how many contracts can I safely trade at any point in time in relation to my available capital. I realize that the assumption is that the system will continue to function in line with past experience. I also realize that the margin will vary with different markets and that will affect the number of contracts -- so for the purpose of this exercise perhaps one can assume that the margin for the bonds is $2500 per contract and that I have $50K available to trade the bonds. In practice, I'd not trade the full amount of available capital -- since I'd want to leave room for draw-downs, etc--but that is something that I will factor in later and need not be considered at this point. I hope that I am clear in what I am asking and what I am seeking to achieve. The objective is to have a formula that I could test out over 10 years and see how effectively it would work. But the end result would need to be a mechanical approach that tells me how many contracts to trade at any point in time -- leaving no discretion -- and in that respect similar to the approach when it comes to buy and sell signals that my system produces. All input is welcome.

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