The Insanity of Intelligent Trade-Sizing

Aug. 24, 2022

No one can go from not making Varsity on his high school tennis team to the ATP Pro Tour in five years.

That’s insane.

Except it happened. I saw it with my own eyes.

And while it was incredible, it wasn’t insane.

Because it happened. And it could happen again.

It’s just so far out of the ordinary, it appears “insane”. The problem is what we do with that insanity.

Do we say, “That’s crazy…let’s try it!” Or do we say, “That’s insane…it’s stupid to even try.”

This week we’re talking about the Kelly Criterion and how to use it in our trading. In the world of index fund zealots (“8% per year is all we can hope for!”), diversification worshippers, and risk-0.5%-per trade educators, the numbers that Kelly produces certainly look insane.

The question is: Are we in the “try it” camp or the “too risky, too stupid” camp?

To examine, we’ll use some free systems from the Newsletter. That way there are zero barriers to entry for anyone wanting to go loco.

First, we’ll look at the Bollinger Band™ 1-Hour Master Trend system on the GBPJPY. The YouTube video describing this system is HERE. You can follow the hypothetical results of this system each month HERE. 

Here’s what Kelly tells us to do. (If you recall, the Kelly Criterion is the mathematical way to determine the maximum, most effective way to bet while not bankrupting your stake. The MIT Blackjack Team used this to make millions in Vegas.)

First, I ran a test from 2003-2022 to get the numbers I need to plug into the Kelly formula. Once plugged in, Kelly told me that the optimum bet level for this system is…(gulp)… 31.8%.

I’m supposed to bet 31% per trade if I’m serious about making money. (I told you it was insane.)

With trembling fingers, I used the new Master Trend robot and ran a test from 2003-2022. I used 30% per trade as my input and started with a hypothetical $10,000 on the GBPJPY only.

Here’s the Report:

Holy macaroni. There’s a lot to unpack.

First, look at the max drawdown percentage. Did you think this was going to zero? I did.

But no. The max drawdown percentage is under 47%. Kelly didn’t bankrupt us. In fact, look at the Absolute Drawdown number. It’s only $5,465. That means our account went below our original stake by 54%. No different than a common, often-occurring drawdown from an index fund.

Now, let’s take in the profit. If we become MIT Blackjack players, our $10k account hypothetically turns into $10,021,543 in under 20 years.

Crazy.

But, over the years, many smart people have admitted that pure Kelly bet size might be too much for humans to handle. The highs and lows might melt brains.

So experts now recommend just using “half-Kelly”. Meaning: take whatever the Kelly formula says and cut it in half.

And here’s what half-Kelly looks like:

It still makes a ton of hypothetical money and its drawdown is only 26%. That’s half of what the stock market does.

It does seem crazy to bet that much and we would definitely suffer losing years and drawdowns that felt extremely uncomfortable.

But the math says it’s not crazy.

The math says it’s just part of doing business.

So, who’s insane: us or the math?

In our upcoming Newsletters, we’ll look at some other free systems.

Talk to you soon.

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Disclaimer:
It should not be assumed that the methods, techniques, or indicators presented in these products will be profitable or that they will not result in losses. Past results are not necessarily indicative of future results. Examples presented on these sites are for educational purposes only. These set-ups are not solicitations of any order to buy or sell. The authors, the publisher, and all affiliates assume no responsibility for your trading results. There is a high degree of risk in trading.

HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN INHERENT LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT ACTUALLY BEEN EXECUTED, THE RESULTS MAY HAVE UNDER- OR OVER-COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN.