17 Jul Complex Versus Simple
Complex Versus Simple
July 17, 2019
“Money management is the most important thing.”
Have you ever heard that?
“Entries and exits don’t matter, only money management.”
Okay, how then do we learn those high-powered money management techniques?
Well, there are books about it. We could read those.
If we have an advanced degree in complex mathematics.
But if the math is over our head, what then?
We could study the most successful system traders of the past several decades: the Turtles.
There are other successful traders, of course, but most aren’t system traders (Buffett, Michael Burry, John Paulson). And they don’t reveal their system publicly.
The Turtles traded a system and their rules are on the internet for everyone.
So let’s look at them. They, too, said that money management was the key to their success.
What did they do?
They believed in volatility stops. That immediately sounds complicated.
What that means is: If the market is moving a lot (volatile), then the chances of stops getting hit is much higher. So the stoploss has to be moved farther away from entry so as not to get tagged so easily.
But if the stoploss is wider, then the risk becomes greater.
Here’s an example. If I trade 4 contracts and have a 100 point stop, that might be, say, $4,000.
But if it’s volatile and I want to move farther away to 200 points, now my risk has doubled. My success rate is the same but my risk is higher.
The Turtles didn’t want that.
So they made up a system. If the stop was wider, they bet less. If the stop was tighter, they bet more. They did this to make sure the risk on each trade was exactly the same.
Smart, complex stuff.
They also had money management rules for trading a big portfolio (they allegedly traded over 20 markets) and also for adding to positions. For now, we’ll just leave those two topics aside.
The Turtles’ stoploss formula is a bit hard to follow but makes sense. The market is always changing, so our money management should always be changing.
Even though we’re told that simple is better, in this case, it seems like complex is better.
Because what’s the alternative?
Using the same trade size for each trade?
If we use 4 contracts each time and the same stoploss each time, we’re ignorantly burying our head in the sand. What will happen to us if we do that?
In theory, we’ll suffer more stopouts in volatile times which creates more risk for our trading. More unnecessary stopouts at full position size can’t be good for our bottom line.
No wonder they tell us money management is so important. By adjusting our risk appropriately, any system we trade is guaranteed to do better.
In our next email, we’ll take a look at a robot I built a while ago that uses the Turtle money management. And we’ll compare that to simple, ignorant money management to see how much better we can do.
Talk to you soon.
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