Interval Analysis 1 Month 3 Months 6 Months 12 Months

Maximum gain ($) 28,900 49,500 57,575 52,413

Maximum loss ($) -7,950 -15,700 -21,800 -15,213

Average ($) 1,047 3,238 6,432 9,479

Standard deviation ($) 5,923 10,613 13,944 14,963

tract system. Comparing Table 7.6 for single contracts with Table 7.7 for multiple contracts, observe that in 1991, the 1-contract system made a 15.3-percent profit, versus a 15.1-percent loss for the multiple-contract system. It is not recommended that you trade an account with so much leverage, and these calculations emphasize this point.

When you increase the amount of account equity, it reduces the fluctuations in equity on a percentage basis. Hence, when you calculate a linear regression on the percentage changes in equity, then you get a smoother curve by using a smaller leverage. This is only natural, since the equity in the account acts like a buffer to absorb small fluctuations when you reduce leverage. You can see this pattern clearly in Table 7.9, which shows the standard error for account sizes of $50,000, $75,000, and $100,000 for the data shown in Table 7.5.

A decrease in the standard error means the equity curve is smoother. As the size of the account increases, the percentage fluctua­tions decrease. Note that our estimated performance band was a good guess about drawdowns. Thus, the 1-month standard deviation of equity returns times four may be a good starting point to estimate downside risk. You can then deduce the account size to maintain a low level of drawdowns. Say you trade six markets, and want to limit the "worst" drawdown to 3 percent. Then you would trade the multiple contract system with an account equity of $800,000. This is very different from the $50,000 account.

Table 7.9 Smaller leverage gives a smoother equity curve on a percentage basis

Account Size

Standard Error of Monthly Changes (%)

$50,000 $75,000 $100,000

2.94 1.96 1.47

218 Ideas for Money Management

The results and discussion of this section should convince you that money management strategies can significantly alter portfolio perform­ance. As stated previously, as a design philosophy, you should try to pro­tect the downside and let the market take care of the upside. In the next section we examine if it is possible to estimate future drawdowns using our interval analysis of the equity curve.