Hypothetical scenario - how much would you risk?

Discussion in 'Trading' started by Cutten, Nov 27, 2003.

  1. Say you have a trade with an upside of 5 and a downside of 1, and the chance of achieving your profit target is 60-70%, what % of your trading capital would you risk on the position?
  2. lefty


    Definitely shoot the works. But it sounds too good to be true.

    Except...I got somethin better - a horse in the third. A sure thing! 8 to 1 !!!

    Give me yours - I'll give you mine.

    Gotta go - the cops just came around the corner.
  3. Well....the Kelly Value says 50%, roughly estimating avg win to avg loss ratio 5:1 at 60% win rate.


    If it is Futures divide 50% with 4 = 12.50% of total equity at risk per trade.

    Michael B.
  4. It depends on how many trades was done to come up with the 60-70%, and how much in time between trades.
    And how many trades in a row to come up with the other side, ie...(30-40%).
  5. acrary


    With such a strong edge the only thing you need to worry about is risk of ruin by betting too large. With the numbers given a 1% risk of ruin would limit bet size to 10% of equity.
  6. Acrary can you give the figures you used to work that out?

    Personally I would risk about 3% on this sort of trade.
  7. TGregg


    Crude experimentation with Excel suggests ~50% is optimum. I'd be more inclined to start with considerably less, and maybe grow to a max of 25%.
  8. There are different risk of ruin formulae floating around, therefore whenever possible I prefer the use of Monte Carlo simulation - luckily the simplicity of this example lends itself to this method. As always, the usual disclaimers apply.

    Of course, if I found a trade setup with these parameters, I would spend considerably more time fantasizing about my future gains than worrying about risk of ruin calculations. Nevertheless, following is a summary of the solutions offered by Cutten, acrary and TGregg:
    Assume we start with $10,000 and execute 25 trades. A sample, therefore, consists of 25 trades,
    and a simulation is 1 million samples ie. a total of 25 million trades.
    % equity         3%                  10%                 50%
    risked        (Cutten)            (acrary)            (TGregg)
    reached        $6,500              $2,300               $0.27   
    equity        $10,900              $9,200                  $5
    equity        $80,500        $5.8 million        $54 trillion
    % of times
    reaching :
     $5,000            0%               0.08%               19.5%
     $4,000            0%               0.01%               16.4%
     $3,000            0%             0.0004%               15.2%
     $2,000            0%                  0%                6.7%
     $1,000            0%                  0%                2.7%
    Note that while equity sinks to a low of $6,500 and $2,300 in the worst case for Cutten and acrary respectively, this occurs sometime during the 25 trades, and in both cases they make recoveries - so much so, that the lowest ending equity out of 1 million samples of 25 trades is $10,900 and $9,200 respectively. This, however, cannot be said for TGregg who actually can and does reach zero (well, 27 cents) and appears to be the only one looking at a realistic risk of ruin. To be fair, he does advocate more conservatism than Kelly, but I thought I'd tempt him with the upside.
  9. acrary


    The formula can be found on p. 136 of Portfolio Management Formulas by Ralph Vince.

    Here's a spreadsheet with the formula plugged in and your numbers so you can change it and see how risk of ruin changes with whatever change you want to make. Only two assumptions are that you don't have a trading goal (trade forever) and ruin = 100% of account loss.
  10. Cheese


    I think it would help this thread if posters could also speak for their current operations (without giving away any secrets).

    So for 1 $10,000 unit of margin I invariably invest $20 so thats a 2% bet size. Now on that size I would stoploss at around $800-$1000 loss or stoploss before the market closes because I won't carry overnight.

    System: my system gives me pre-determinates of very high probability so I'm not looking to take a loss on any day but my stoploss parameter is there nevertheless. The other thing is that usually I do not strain what is available from the days gyration pattern. My speciality is the YM so I want a gross 55 point move, above or below the Open. Usually it does that or more each day and its never a problem when its a narrow range day.. just can't do target profit when that happens.

    I'm pretty cautious so I don't use half what my system offers me. I don't yet use my system on other futures index markets though it would work elsewhere. The only reason I can be such a strong player is because I let gains constantly accrue and then every now and then increase stake size which is never more than 2% of my total margin (capital+net gains).

    So perhaps to enlarge this debate, what parameters/stake size/percentage do you operate?
    #10     Nov 28, 2003