Fixed Ratio Money Management

[HornedGod]

Does anyone have experience in applying the Fixed Ratio money management approach, as advocated by Ryan Jones (in his 'The Trading Game' book).

For those who are unfamiliar with this book, you can also try before you buy here.

If so, how have you found using the Fixed Ratio approach compared to the more standard Fixed Fractional/Optimal f approaches? Has it improved your trading? Has it had a positive impact on your psychology in being more confident in the way you handle your money management? Who disadvantages have you found in using the Fixed Ratio method?

 

[sidinuk]

Brilliant question HornedGod, and thanks for the link.

I do use a fixed ratio method. Basically he is saying that the more trading capital you have the more psychologically damaging the drawdowns are. For example if you lose £5,000 it hurts a bit but you can quite easily replace it. If you lose £500,000 it hurts a hell of a lot more and you can't easily replace it.

It makes sense, to me anyway, to be more aggressive the less you have in your trading account and more conservative as you build it up to protect those gains. It will take forever to build £5,000 into a sizable sum using a fixed 1% risk (£50 per trade!!). But why be so conservative with such a small amount that's easily replaceable? If it isn't then you shouldn't be trading with it.


Do you think the number of contracts should be determined by the actual account balance or the maximum account balance? For example at $20,000 you increase to 2 contracts. A small loss then takes you back to $19,500. Do you trade 1 contract based on the fact that your account size is under $20,000 or 2 because you had reached that level? I'd like to stick at the new level once it is reached but that obviously increases risk. This is the question that keeps me awake at night!!

 

[Glenn]

Sidinuk
"Do you trade 1 contract based on the fact that your account size is under $20,000 or 2 because you had reached that level? "

Prudent to revert back to 1 until you break the 20k barrier again imo. Otherwise you are breaking your original risk-management rule.
Staying at 2 is cocky and greedy - you could lose again on the next trade and be down at 19k. With further losses, at some point you may be forced to revert to 1. That point needs to be decided in advance of such a scenario. Where would you place it ?

Problem with the step from 1 to 2 is that it's the biggest step you are likely to take as you progress up the scale. e.g. Going from 2 to 3 is a smaller step etc etc.
Glenn

 

[sidinuk]

Glenn you are quite right.

These are all just examples, if you are prepared to trade 1 contract at $10,000 then 1 contracts at $19,500 is very conservative.

Say you expect a maximum drawdown of $4,000 per contract. If that happens at $10,000 it's 40%. At $19,000 with 1 contract it is only 21%. At $20,000 and continuing to trade 2 contracts throughout it is $8,000 or 40% again. Ie by staying at the higher contract number you are taking on exactly the same risk that you were prepared to take at $10,000.

Now the beauty of the fixed ratio method is that the gap between jumping up contracts is larger each time, so in the above example if $10k is the first level then the next might actually be $22k, in which case the $8k drawdown is only 36% staying on the max no of contracts. Each level up this percentage will get smaller and smaller even basing the number of contracts on the maximum bank not the current bank.

I take your point though, you could stay on 2 contracts until you get back down to say $15k in which case you then come back down to 1 contract. You give yourself some breathing room at the threshold in order to get cleanly through it.

Oh so many choices..let alone deciding how you are actually going to trade and make a profit in the first place!

 

[HornedGod]

Rate of decrease

To cope with drawdowns I'm using a 50% rate of decrease (as detailed in chapter 7 of the book).

What this means is that if I reach a level where my profit level allows me to increase my contract size by one, I won't decrease the contract size unless my account size is half way between the two previous contract increase levels. An example is probably the easiest way to demonstrate this:

Starting capital: $10,000
Number of contracts to start with: 1
Delta: $2000

Given the fixed ratio formula:

Previous equity level x (No. of contracts x delta) = Next level

The levels at which I will increase my number of contracts would be:

Number of contracts---->Account size
-----------------------------------------------

1 ----> $10,000
2 ----> $12,000
3 ----> $16,000
4 ----> $22,000
5 ----> $30,000
6 ----> $40,000
...

So once the account size reaches $12,000 you start trading two contracts.

With a 50% rate of decrease, you would only go back to trading one contract if your account size was half way between the previous two levels (i.e. half way between $10,000 and $12,000 = $11,000).

If you were up to an account size of $42,000 (trading 6 contracts), then you would only start trading with 5 contracts if your account balance fell to below $35,000. You would go to 4 contracts if it then fell to below $31,000, 3 contracts below $28,000, etc.

You are basically decreasing twice as quickly as you are increasing, while still giving yourself a bit of breathing room once you just pass the next balance size required to increase your contract size.

 

[Glenn]

"1 ----> $10,000
2 ----> $12,000
3 ----> $16,000
4 ----> $22,000
5 ----> $30,000
6 ----> $40,000
..."

When you move from 1 to 2 contracts, you are doubling your size and risk in one go.
When you move from 2 to 3 it is only a 50% increase.
When you move from 3 to 4 it is only a 33% (edited) increase. etc etc.

Must admit I haven't read the book, so I don't know how the Delta is derived, but the steps in your table above don't seem to correspond in proportion to the capital.
The highest risk step (1 to 2) is at the beginning and yet it relates to the smallest increase in capital.
Perhaps I haven't got my brain round this yet but it seems all wrong to me.
Glenn

 

[HornedGod]

Glenn, sorry for causing any confusion there. My numbers were purely for demonstrative purposes, and not meant to be realistic or take into account risk.

Where the Fixed Ratio gets its name from is that increases in number of contracts should relate to a fixed ratio increase in capital.

Using made up numbers again, with a starting capital of $20,000, using one contract, and a delta of $5,000:

1 ----> $20,000
2 ----> $25,000
3 ----> $35,000
4 ----> $50,000

Going from 1 contract to 2, you need to make $5000. Going from 2 contracts to 3, you need to make $5000 per contract, i.e. there is a fixed relationship between increasing the number of contracts. You need to make the same amount of profit from each contract to increase. This is in contrast to the fixed fractional method where the greater the number of contracts, the less profit per contract that is needed to increase to the next contract level.

Your starting capital, delta value, rate of decrease, all have to calculated by the individual trader to match their trading approach (risk, etc). The numbers of contracts used on a trade should remain within the risk parameters set by the trader. If the number of contracts to be used combined with the proposed protectice stop loss position voilate the risk amount allowed for a trade, then the trade should not be taken.

 

[esiotrot]

hi
Have a look at Mike Diplocks trading pages, in particular these slides from one of his presentations. There are links to discussions about fixed ratio v fixed fractional.

Try this link

 

[sidinuk]

Nice idea HornedGod about the 50% rate of decrease, I'm going to look and see if I can incorporate that into my money management rules.