I am working on developing the position sizing module of my system and I am trying to figure out how to correctly apply the Kelly criterion to stock trading. The Kelly criterion was adapted to these purposes by professional gamblers. My problem lies in that, in the gambling scenarios that it was adapted for you only have one "position" at a time so your bank roll is adjusted to include the outcome of you last position before you have to size your next position. However in stock trading you will have multipole open positions at a given point in time, so should the kelly number be applied to your present level of equity or present level of cash?
Imagine you hold only 1 position at the time. Would you apply your formula to your present equity or cash?
If the system held only one position at a time then the previous position would be closed out before the second position was enetered, so for the purposes of position sizing cash and equity would be exactly the same.
There has been plenty of discuss about PS and Kelly on here. Trading does not have fixed outcomes like gambling, so I would never use the kelly value unless you are trading on fixed setups with gambling like characteristics. Usually the simplest form is best: PositionSize in dollars = 1% of capital risk * (Buyprice or Shortprice)/ ATR(20); ATR value can be changed to suit whatever timeframe you use. Days, Hours, Minute values for Points, ticks, cents... etc... Never risk more than 1% of capital on any trade.
Hi, I've tested a software that let you simulate several PS Strategies. The software is the MSA. May be you can find some on their site. I found it very good to implement a PS Strategy to my own strategy. I've posted some info on it at http://www.elitetrader.com/vb/showthread.php?s=&threadid=75263&perpage=6&pagenumber=15 I cant remember if they provided the Kelly criterion, but you could check with them.
If you imagine for a moment that you sold your position to open a new one then the value in your account after the sell is what you should go by which makes it equivalent to current cash + equity. But in cases you can use only your cash to open a new position it makes your risk in practice even smaller.
I disregard the Kelly criterion. It is the drawdowns that concern me. Risk has to be small enough so that the drawdowns do not make me feel sick. That seems to be less than 1 % risk using long term position trades.