From the August 01, 2010 issue of Futures Magazine • Subscribe!

Money management: Putting theories to work

Trade management is where professional traders make their money. In our first installment, we showed that performance of one-lot trades varies significantly when filtered based on risk as opposed to volatility. When professional traders do trade management with large accounts of several million dollars, they are sizing to maximize risk-adjusted returns and do not need to filter out trades to limit risk. Although most individual traders aren’t moving millions of dollars through the market with each trade, they can still benefit from these concepts.

When designing trade management tools, there is a right way and a wrong way. The wrong way is to create a list of trades and then apply the trade management rules to them. This is incorrect because the real life trade might not be the same due to the trade management rules. Assume we are willing to risk 5% of our account on a given trade and have a $100,000 account. If the risk on a given trade is $5,500, we would skip this trade. However, say that four days later we get another buy signal with a risk on the trade of $4,600. Now, we would buy, but the entry date would not match our original sequence without the risk management overlay. The trades would be different.

It seems simple when stated that way, but most trading software puts the trades on first, and then applies the overlay or risk management strategies. Examples of software that integrate risk management with trade selection are Trading Blox, Mechanica and TradersStudio. (Disclosure: TradersStudio was designed by the author.)

Understanding the process

Here’s how it works. The software processes the trades for the next time period and then passes control to the trade-management engine, which can modify orders or even place new orders. Next, control is then passed back to the system to execute for the next time slice.

We can match intraday with daily. For example, if we have two systems, a 15 minute and a daily, the 15-minute one would run on one 15-minute bar at a time, with risk management modifications, and then at the end of the day we’d run the daily system for a given bar. This means that the systems and markets run in parallel. Looking at how this is done, we will first examine a simple example, built for TradersStudio (see “Percent margin plan,” below).

chart
Sub TSPro_PercentMarginPlan(Percent,Ceiling)
Dim S As Integer
Dim M As Integer
Dim DollarPerTrade
Dim NumberOfMarkets
Dim DollarsPerMarket
Dim StartAccount

If tradeplan.MarketType<>0 And tradeplan.MarketType<>4 Then
MsgBox("This trade plan can only be run on Commodities,Futures")
StopRun
End If

If Tradeplan.SummEquity
MsgBox "not enough money"
StopRun
End If

If Tradeplan.SummEquity< Tradeplan.TotalMarginForPlan Then
MsgBox "Margin Call Account below minimum margin required"
StopRun
End If

NumberOfMarkets=TradePlan.MarketCount
DollarsPerMarket=tradeplan.SummEquity/NumberOfMarkets

' Loop though all the sessions
For S = 0 To TradePlan.SessionCount - 1
TradePlan.Session(S).UnitSize = 1
' For each session Loop though the trading plans.

For M = 0 To TradePlan.Session(S).MarketCount - 1
print TradePlan.Session(S).Market(M).Margin
If DollarsPerMarket>TradePlan.Session(S).Market(M).Margin Then
TradePlan.Session(S).Market(M).EntryNumUnits =
Min(Floor((DollarsPerMarket*Percent/100)/ TradePlan.Session(S).Market(M).Margin),Ceiling)

Else
TradePlan.Session(S).Market(M).EntryNumUnits=0
End If

TradePlan.Session(S).Market(M).ExitNumUnits=TradePlan.Session(S).Market(M).NumContractsHeld

Next
Next
End Sub

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