When Is A Profit, A Profit? (Success Series)

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.

https://dl.dropboxusercontent.com/u/10422981/2016-04-14%20Excel%20Blog.wmv

(Link  to Excel: https://dl.dropboxusercontent.com/u/10422981/2016-04-14%20Profit%20and%20Loss%20Sequence.xlsx)

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.

don-scott-bio.pdf

fixed-ratio-money-management.pdf

13 thoughts on “When Is A Profit, A Profit? (Success Series)”

  1. hi Ray,
    I diagree with Kevin Davey randomized order of returns concept.

    I would run randomized order of price changes, then determine return for every run.
    – assuming the price changes are not co-related!

    ___

    It seems to me that:
    If you trade fixed percentage, with constant win ($W) and loss ($L) for each trade, your final equity is the same regardless of the order.

    Paul

  2. Here is another resource that some may find useful and it is 100% free. I suggest ignoring any of the comments about returns.

    http://zorro-project.com/features.php

    Zorro is the first free platform for research, exploring, developing, testing, and executing automated strategies on a serious level. It can run either as a stand-alone system with direct broker connection, or as an attachment to a trading platform (such as MetaTrader4) that is used for retrieving price quotes and sending commands to the broker.

    It includes free coding and trading courses with lots of detailed explanations, examples and code:

    http://zorro-project.com/manual/en/tutorial_var.htm

    •Bootstrap / Monte Carlo analysis with randomized price and equity curves and much more.

    http://robotwealth.com/my-experience-dealing-with-zorros-support-team/

    “Zorro now includes a bridge to R enabling direct use of R functions in trading, optimizing and backtesting Zorro scripts”.

  3. Given the recent mentions of Monte Carlo simulations here is another interesting application:

    http://jonathankinlay.com/2016/03/a-new-approach-to-equity-valuation/

    ” That allows you to model the cash flows using Monte Carlo simulation and discount them using the risk-free rate, which is much easier to determine”.

    “I recall taking the idea to an acquaintance of mine who at the time was head of M&A at a prestigious boutique bank in London. About five minutes into the conversation I realized I had lost him at “Monte Carlo”.

  4. hi Chrisj,
    I am interested in developing Automatic Trading System (ATS) for the MT4/5 platform. I
    am looking for a good platform to perform development, optimizing and testing.

    Thanks for your references.

    A great help!

    Paul

  5. Hi Paul,

    I am glad you found it helpful.

    I will pass on a comment from a very experienced quantitative/mechanical system trader in case your category is Forex.

    Despite creating a number of profitable systems used to trade live accounts they have still not been able to find a robust system for trading Forex.

    As a DRB Ray trades Forex successfully.

    Make sure whatever system you come up with is properly tested (ala Bandy etc) and if you intend to use real money I would suggest that the results be reviewed and challenged by a quant expert.

    Chris

  6. hi Chris,
    The very experienced quantitative/mechanical system trader developed robust system to trade Forex futures but not spot forex?

    What you mean by robust?

    My belief is that every forex pair should have its own optimized trading system to trade, each for EUR/USD, GBP/USD …

    Andrea Unger did that for forex trading.

    Paul

  7. Hi Paul,

    Neither currency futures or spot forex.

    I was using “robust” as a bit of a catch all term (being a bit lazy :)). To cover different periods of volatility, trending / non trending periods and so on.

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