BarroMetrics Views: When Is A Profit, A Profit?
Actually, what I am asking is: when do we add profits to our capital, and when do we deduct losses?
The question is not an academic one as the Excel attachment shows. Click the link below to download the video for an explanation of the spreadsheet.
When using the ‘% of capital’ approach, it’s important to appreciate this:
“If encounter an ebb phase at peak equity we’ll suffer our largest loss. And, if we encounter a flow phase at equity trough, our profits will be the smallest.”
To seek to even out the fluctuations, I use a dictum of Don Scott.
Now, if you aren’t Aussie, and over 40 years old, you aren’t likely to know of him. So, I have attached a short bio.
But, if you lived in that era, you’ll remember how much of a splash Don made in the punting (betting on horses) world. He placed the endeavour on a rigorous approach. Part of this approach revolved around money management. He took the view that, if yesterday’s bet for a 33% selection was $X, then today, the bet size for a 33% choice, should be the same.
While Don’s logic is inescapable, it doesn’t quite fit my number one guideline, ‘preservation of capital’. The issue was this:
- I wanted to keep the dollar risk the same when I experienced the ‘normal’ loss, and
- I wanted to reduce the dollar risk in drawdown mode (ebb phase).
The question was how to do this?
Ryan Jones suggested an approach, Fixed Ratio Money Management (see PDF). Unfortunately, for me, the approach did not suit me. So, I had to find my own path. What it is, we’ll look at the next blog.