BarroMetrics Views: Risk Management IV
Both Baz and Paul raised some questions.
From Baz’s comment, I feel I may have given my readers a wrong impression. I assess Ebb, Flow or Normal, from the Expectancy Return, as well as % of capital lost and made. I use Steidlmayer’s frequency distribution method to assess if I am normal or at one of the other extremes (positive or negative).
I calculate 3 sets of stats:
- A set that encompasses both profits and losses.
- A set that encompasses only % of capital lost.
- A set that encompasses only % of capital made.
Figure 1 is an example of a set that includes profits and losses. In this set I am using the expectancy ratio i.e. % of profit when compared to % of capital risked. My normal range is between ‘2.0’ and ‘0.8’.
So, any drop into the range ‘0.4’ to ‘<0.8’ for 3 consecutive trades, sends a warning signal that I am below Normal. If the other two sets confirm, then I would deem me in Ebb Stage. Sometimes it only takes two consecutive trades to make this assessment. At the end of the day, it is a judgement call based on the info.
I do the same for Flow – I enter flow once I have 3 consecutive trades in the ‘2’ to ‘<2.4’ zone.
Paul asks :
Average Profit/Loss per trade
Average Profit/Loss per standard contract/lot
b. Also “normalized” the Expectancy by unit risk taken”
Paul, these are your stats, use what assists you. I use both ‘avg per trade’ and ‘avg per contract’. In an ideal world, the two would be equal. In the real world, there will be a difference. If the difference is substantial, then you have important info.
For example, if currently my avg per contract is greater than my avg per trade, that tells me I am increasing and/or decreasing position at times that are adversely affecting my bottom line. On the other hand, if currently my avg per contract is less than my avg per trade, that tells me I am increasing and/or decreasing position at times that are beneficially affecting my bottom line i.e. I am increasing position size at the right time.
I don’t use normalised Expectancy because I prefer to assess the results on a per instrument basis. Figure 2 shows the stats produced. In addition to all the trades, the stats are given for each instrument and rule.
I’ll turn to Manish’s question on leverage tomorrow.