BarroMetrics Views: When Is A Profit, A Profit? 2 (Success Series)
In the last issue, I considered the question: when do we add profits to capital? When do we deduct losses from capital? I introduced Ryan Jones’ approach.
Speaking of Ryan Jones, he has a sale on for his course starting Tuesday, April 19 and running for two days: see Fixed Ratio on Tuesday.
His course is normally USD 797.00; on the sale, his price will be, USD 197.00. And ‘no’ to those who will ask, “I am not receiving a fee for referring the course’. In fact, Ryan does not even know I have mentioned the saving).
Turning back to my subject……
Ryan’s approach does not suit me. I prefer to use another method – not better, just one with which I am more comfortable. My take requires we know:
- Number of historical consecutive losses
- Avg consecutive losses
- Loss Rate
- Population Size
- Avg pa return on capital (Avg ROI)
Let’s take my trading. Taking my trading results since 1990 (when I began the private limited partnership fund), we have the following results:
- Historical consecutive losses: 16
- Avg Consecutive losses: 4
- Loss Rate: .485
- Population size: 2210 (i.e. number of trades over the period, about 7 trades per month)
- Avg pa return on capital: 27.63%
Firstly, the data allows me to calculate the theoretical consecutive loss: 10.64 (say 11). So, I would not consider the consecutive loss sequence of 16 as an outlier. (If I did, I would need to reassess the data. For example does the data show a period of extraordinary losses?) With a run of 16 losses, if I risk 2% per trade, I’d risk a loss of 32%. Since my average profit is only 27.63%, I am not prepared to run that risk.
What if I risked 1%? My possible loss would be 16%. Still a little high – I am aiming for a risk of around 50% of average ROI (14%). So, I’d bring down the risk per trade to around 0.90% which I find an acceptable risk; I treat the 0.9% as my ‘normal’ size.
Secondly, when to add to capital? I’d add on any increase above 50% of average ROI = 14%. And finally, when to subtract losses from capital? I’d subtract losses whenever I’d lose 50% of the increased value (i.e. 50% of 14 = 7%).
So far we have determined what I would consider ‘normal size.’ I have one more step to determine my position size for the current trade: I have to decide whether my trading is currently in Ebb, Flow or Normal State.
More on this tomorrow.