Ideas for Money Management Interaction: System Design and Money Management

This section examines the effects of two different money management strategies on portfolio performance. First we examine the effects of trad­ing a system with a fixed or variable number of contracts. Then we see how portfolio performance differs for the two strategies. Finally, we check if our interval equity changes are useful for projecting worst-case drawdowns.

Vow goal is to take care of the downside, and let the market take care of the upside. You would like to maximize the rate of growth of ac­count equity while managing the extent of cumulative losses. Money management involves all the decisions specifying amount of capital risked per trade. This, in turn, determines the number of contracts traded. The contracts traded impact the percentage of account equity al­located to margin dollars. Of course, you must also choose the markets traded in each account. Yov. can use relatively simple rules or relatively complex rules to make each of these choices, but your choice can signifi­cantly alter account equity evolution. You can also trade the same system with different money-management limits to produce significantly differ­ent results. This section briefly discusses common rules and shows their effects, but you should also review other books devoted just to this one subject.

The simplest risk control tool is an initial risk or money-manage­ment stop. This is usually a hard-dollar stop, with the dollar amount be­ing usually less than 6 percent of your total equity. A hard-dollar stop is simply the amount of capital at risk per trade, usually implemented with a stop-loss order. Thus, you will exit the trade if the loss on all contracts approaches the hard-dollar stops. For example, we saw in the previous section that the usual choice is to risk 1 to 2 percent of your total equity on every position. Then, if your risk per contract is smaller than the to­tal risk, you could trade more than one contract.

You. are making a trade-off between the rate at which you want your equity to grow and the drawdown you are capable of absorbing. Theories such as optimal-f use more complex formulas to increase eq­uity growth beyond the one-contract-per-market approach. However, when you trade multiple contracts, the drawdown tends to increase, and hence money management becomes even more important.

We can examine the interaction between system design and money management by using a channel breakout system on the deustche mark using actual contract data with rollovers. The monthly equity curve for the system trading one contract with $100 allowed for slippage and

Interaction: System Design and Money Management 213