Let's say that I have a capital of 3000 $ and that my system's maximum drawdown is 750 $, with 1 contract traded. Let's say we can expect a (future) maximum drawdown of 1500 $, that is twice the maximum drawdown resulting from backtesting the system over x years of data. Now, in order not to be wiped out by losses, do you agree that I will need to have a capital of 3000 $ for each extra contract I want to trade? In other words 3000 $ to trade 1 contract, and 6000 to trade 2?
Some of the best trend following hedge funds have a margin-to-equity ratio no greater than 10%. Your M/E ratios and VARS will determine whether your biz lives to see the next day in the event of a substantial move against your position. There is a difference between asking for trouble versus running into trouble.
Just found this in my archives. "Technically, the forex market allows you to trade with a margin of 100:1, meaning you would need only $1,000 to control a currency contract worth $100,000. Because Chicago can never be in more than 24 positions at the same time (8 markets, times 3 systems) this would mean that our maximum theoretical margin requirement for trading one contract per position would be $24,000. Because we think this is way too risky, we use an internal margin requirement of $5,000 per contract, which in turn is more than twice the size of any maximum expected loss for 95% of the trades taken by any of the systems making up Chicago. Now, because we do not want to lose more than 1-2% of our total account equity in any given position (we will never ever take a position without also placing a corresponding stop-loss order), this means that we demand an account size of $250,000 per contracts traded in any given trade (1% of 250,000 equals $2,500). This gives us a maximum technical margin-to-equity ratio of 9.6% ($24,000 / $250,000) and an average daily ratio way below that. Our maximum internally demanded margin-to-equity ratio comes out to 48% of $250,000 with an operative average around 25%. This is depicted in the chart below. Another way to put this is to say that with only one open position (out of a maximum 24 possible) our leverage will be a modest 0.4:1 (compared to a maximum of 100:1). With all positions on (which will seldom be the case) our maximum leverage for one currency will be 1.2:1, and for all currencies it's 9.6:1. Under normal circumstances the average daily leverage will rest around 5.6:1. It is the hallmark of a good money manager to be able to produce a competitive return requiring as low as possible leverage and margin-to-equity ratio". Hope that helps.
Well, thanks to everyone. Your posts were right to the point, even though quite complicated for my limited knowledge of the subject. I will try to learn more so to be able to understand them.