Magic Money Management Formula

Discussion in 'Risk Management' started by 777, Nov 4, 2006.

  1. 777


    I am learning quite a bit about trading reading Elite Trader.

    However, many posters on many threads seem to feel there might be a Magic Money Management Formula that will make them winners. Since this is an area I know a little about, I will hazard an explanation regarding this topic.

    MONEY MANAGEMENT alone will not make one a winner in the long run.

    A trader (or gambler) can not win in the long run without a "POSITIVE EXPECTATION" on his trades or bets.

    RISK MANAGEMENT will help make a trading account grow and protect the account from temporary adversity IF the trader has a winning methodology for entering and exiting. Over-betting a bankroll often leads to ruin. Always doing this always leads to ruin

    A casino guarantees themselves a "positive expectation" on the bets they make (take) by paying "less than is mathematically breakeven".
    Example: Even money on red when playing Roulette even though the gambler has about a 48% chance of winning this bet.

    A casino manages its' money by not taking on too much short term risk.
    Example: Caesar's Palace would never let Bill Gates bet $2,000,000 a spin on Roulette because in the short run he could get lucky and bankrupt the casino. Caesar's would gladly let a player bet $100,000 (or more) a spin as the casino can survive streaks of "bad Luck" for these amounts.

    In the casino, players with Money Management Systems (usually progressions) are treated like kings and never bared from playing!

    There are many names for one key concept: Positive Expectation,The Edge, Overlay, The Best Of It, Getting paid more than is fair, Positive Risk/ Reward, etc. Whatever a trader, gambler or casino call this concept.. they all must abide by it to be winners.
  2. Thats exactly what i think. Many traders assume a positive expectancy for their trading systems for the future and then take that for granted and chose then a money management framwork. But it could become a negative expectancy play.
  3. money management is used to refine a good system and make it better by protecting capital.

    money management is NOT used to make a bad system good.
  4. elit


    But with good money management a bad system could be trader for a longer time! And the trader would beleive the system is better than it is... :D
  5. the point is, and from talking to many failed traders, it seems to be the case, is that most traders fail. and imo, most traders fail because of a few big blowups (especially one big blowup followed by a revenge trade - that ends up in a bigger blowup)

    ultimately, these are failures of character/emotion/money management/discipline, which are interrelated.

    of course, good money management combined with a losing system or methodology will just mean you will lose your money more slowly :)

    but i'm pretty convinced most traders BLOWOUTS (and i dont think most losing traders whittle an account down, as much as they suffer from blowouts) could be rectified by money management discipline.

    i also think developing an edge is less difficult (for most) than developing discipline and proper money management.
  6. 99.999% curve fit.
  7. I generally agree with what has been said here. There needs to be a net positive expectation in the investment to win in the long run. Of course in the long run we are all dead anyway - so the semantic of "long" is ambiguous or pragmatically irrelevant :D

    One of the little expensive truths I have learned recently is the error of having a high probability investment but over betting/investing the position and losing early. An example of this would be an established long term and tested back track record of +90% probability of returning small monthly profits on the order of 3-9% seen in selling various cheap gamma option spreads. When the trading system is crippled by unfortunate and moderate to large early losses the time to get back to "even" can completely ruin the best of systems since no one wants to sit around for a year working hard to get back what was lost. Losing big and early is just plain devastating to morale as well as principal. In that sense even the most disciplined investor operating in these loss scenarios will more often than not succumb to emotion and attempt to increase risk to accelerate faster and win back lost principal. The pattern is predictable and such often end up of course losing it all.

    I suspect that a lot of the various commercially available trading systems that are back tested with paper have picked and chosen convenient "starting" dates to avoid early loss scenarios. They will show token losses later in the revenue streams to give a false credibility of being honest that they on occasion lose. The truth though is often these systems, depending on when a trader starts them can fail early. This is the real problem with these kinds of systems though. I have since glomed onto a concept called the Kelly principal ( ) which is just one of a large number of other betting strategies ( that shows pragmatic promise in preventing the early and large "wipe out" investment.

    The key though is having the iron fortitude and discipline to keep to the slower gains and never over bet/invest one's principal to get back faster on losses or to win more quickly. In investing its always been a matter of risk-reward balancing and never putting large bets on any one single thing. Those that violate this old truth can win big and walk away huge winners but if they later come back and try it again they often lose everything.

  8. Money management is the only thing you can CONTROL in the markets. If you don't have solid money management you will not be successful over the long run.
  9. yes. position sizing is essential

    one thing that many traders don't understand is that even if ur system has 90% winning trades, you can still have 6 losers in a row.

    given sufficient "n", you are practically guaranteed that.
  10. AMEN. Everyone should learn this lesson the hard way one time to make it sink in.

    #10     Nov 6, 2006