There is a LOT of variants discussed out there on them internets... For example, this: http://www.distressed-debt-investing.com/2010/04/kelly-formula-and-event-driven.html
Daal, kelly f is: (r-Rf)/v, were r = expected return, Rf= free-risk ret, v= expected variance of ret Tipically you use history to forecast r and v. If r and v come from past real trading 1/2 kelly is ok, but if they come from backtesting I suggest 1/4 kelly or less. Better to have not max log-grow of money, than broke
That's the idea of sizing to the max drawdown thing. If your assumptions are off, depending how frequent the system trades, it still might take a long time to produce the 99% drawdown that hits the max drawdown level. So from that perspective, its conservative. Not only you have to be off by a significant amount, you also have to be unlucky enough that the streak of losses necessary to produce the max drawdown happens in your lifetime. But I'm just speculating and thinking out loud here. Was wondering if there is a flaw into this thinking
Its a variation of the Optimal F that takes into account max tolerable drawdown http://signaltradinggroup.com/wp-content/DCSArticles/Securef.pdf
All these are variations of the same idea, which can't address the fundamental uncertainty inherent in estimating the inputs. Sure, you can run any number of backtests or Monte Carlo simulations to get some flavor of F, which will fit in that particular instance. In other words, you can data-mine to your heart's content, with whatever personal constraints around the drawdown. I don't see anything too exciting about that. FWIW, if you read the comments on Ernie Chan's blog post I mentioned earlier, you will find a similar discussion.
I'm not sure how off one's assumptions have to be for a 1/2 kelly/optimal F size to generate the drawdowns of the full kelly amount. I believe they have to be large. And if the person is making those large errors, isn't it likely he is a losing trader and hence no position sizing can save him? By sizing to the max drawdown with some safety nets, the trader can extract the max profit per unit of tolerable drawdown Now, I don't necessirely think this is a holy grail, your idea of using stress levels as one of the inputs also deserves consideration. Some 25% drawdowns might be tolerable in some instances but not at others due life circumtances, etc
I agree and, if you look at the link in my other post (the Tiburon one), I think those guys broadly agree with you as well.
One downside is you will do a lot more position size related trading So if you lose 12.5K you'd cut your position in half; then double your positions when you make it back. IMHO it's better to trade an eighth (half times a quarter) optimal F on the full amount you're willing to lose. If your trading capital is 100K that ought to be what you're prepared to lose. This gives you the same effective risk as using half optimal F on 25K, but if you lost 12.5K you'd only reduce your positions by 12.5%, so less trading. GAT