Calculating minimum capital

Discussion in 'Risk Management' started by Stoopidly, May 17, 2013.

  1. Hey,

    I have been searching around for a while to come up with a formula for calculating the minimum capital I'd need for my system(s). After thinking about it a little while I realized that calculating something like that is very subjective to each person. People have different criteria for what they consider safe, or lets them sleep at night.

    I tried making my own, simple calculation. Looks like this:

    (MaxLoss * (1 + Margin))*(1/DrawDown) = Capital needed per contract

    (5000*(1+0,25))*(1/0,15) = ~41600

    MaxLoss: Biggest loss incurred on 1 contract during whatever backtested period (10 years for me on daily EOD).
    Margin: I used annual VIX as a reference (trading ES). It's just a safety margin on my max loss.
    DrawDown: What I consider an acceptable drawdown/loss.

    I guess this also heavily depends on what kind of system you'd be running. For my system, using max loss seemed like the best idea. I have thought of using max consecutive losses as well.

    Would love to get any kind of input on what you all think about it. I'd also like to see how others calculate minimum capital.
  2. ofthomas


    did you take into account inflation given you are going back 10 years? was that maxloss a one time?

    personally, I would use the worst drawdown period... amd double it...
  3. I didn't think about inflation, thank you for pointing that out. Now it looks something like:

    5000*(1,025^10)*(1+0,25)*(1/0,15) = ~53350

    I did think about just doubling my max drawdown, however, for me that would look like:

    15000*2 = 30000

    I regularly have an open position drawdown of 2000, which would translate to a regular 6,7% drawdown.
  4. I like to keep things very simple and so I've come up with a calculator to fin the best relationship between the broker fees and the size of the position. This calculator is for options because most brokers charge a flat plus an additional fee per contract.

    Based on the chart, the steepest part of the curve is passed after the first 8 contracts. My personal decision is that I will not trade less than 8 contracts due to the high percentage that goes into the cost of the fees. So my account size minimum would be based on being able to trade 8 contracts at a time.
    My rule is that if I can buy 8 contracts while keeping my risk limit near 2% max, then its a go.

    Example, my entry is at $3.00 per contract and my stop is at $2.75 per contract. That's a $25 loss per option contract. If I had 8 of them, the total loss would be $200 plus fees, so my total account size would have to be just over $10,000 to make the trade with a 2% max loss. If I only have $8000, then my trading is limited to risks of only $20 per contract.

    With stocks the formula would be different, but the idea the same. How much do you need to minimize the cost of fees while meeting the risk management requirements of your system?

    Edit: This is for growth, though, assuming you have another source of income. Not for living on.
  5. Yeah, I try to keep things as simple as possible as well. I find it more 'robust' the simpler it is. Your calculation looks pretty similar to mine in essence. You have specified a certain risk capital per contract.

    For me, fees are not really much of a concern, as I trade on daily basis. Holding from anywhere between one day to two weeks. It's basically ~$4 per round trip/contract, so I haven't taken it into my calculation.

    It kind of hit me that having an accurate measure of your minimum capital per contract/option, whatever, is just as important as finding an edge while trading. If you don't have enough, you run the risk of getting an unexpectedly big drawdown, maybe even lose it all. On the other hand, if you use too much capital for each contract you basically have money just sitting there. So finding the right balance has been very important to me. This obviously depends on the different strategies.

    I tried opening your document but I just got a corrupt file error.
  6. Try this one. I screencaptured the excel doc. Basically, with my broker's fee structure (Tradeking), the fees look like this as a proportion of the position size.
  7. dom993


    A simple formula is:

    Capital = 3*MaxHistoricalDrawdown + Margin

    The 3 multiplier puts you on a reasonably conservative foot, using 2 instead of 3 for that multiplier is quite aggressive.
  8. @J.Joseph
    If you trade frequently I can see how that adds up quite a bit over the course of a year. Just shows how important it is to consider even things like that, no matter how insignificant it might look like. Thank you for the screenshot.
  9. I must appreciate you simple formula and it will really help me when I will be following a signal service because the starting capital calculation is very important.
  10. Pipflow


    This is really good calculation for the long term traders when they have to hold huge drawdown.
    #10     May 29, 2013