From the April 01, 2011 issue of Futures Magazine • Subscribe!

Taxes and money management: After-trade management

Balance and rebalancing

Let’s compare a system that uses volatility-based money management (dynamic margin) and its trade plan to a second system that automatically exits 50% of any position that reaches 20% of the account value. If only one contract is owned, it will exit the complete position. This can be done with the code shown in "Quick exit" (below).

Click here to download the following code in a Word document.

image

Here are the results:

Compound Annual Growth Rate
Normal 17.84%
Using Rebalance rules 19.21%

Percent Maximum Drawdown
Normal 20.96%
Using Rebalance rules 19.04%

Sharpe Ratio
Normal 0.7636
Using Rebalance rules 0.8558

MAR
Normal 0.8513
Using Rebalance rules 1.0089

The rebalancing approach can improve the growth rate and lower drawdown. We improved both the Sharpe ratio and MAR significantly by exiting a few trades with these windfall profits. Rebalancing is a good tool for trend-following methodologies, as many times you will give up half of the open position profits on a trade.

This sensible exit approach is one of many that today’s modern trading system analysis tools allow us to test. Other examples include:

a) Stop trading if you lose N% in a given month.

b) Stop trading if you make N% in a given month.

c) Rank market by ADX and only take trades of top trending markets.

d) Rank market by other measures and only take trades of top trending markets.

e) Balance risk on long/short positions; for example, skip trades in times when the majority of signals are on one side of the market.

f) Balance risk by sector.

These ideas are just a starting point for what you can test. ADX filter is a good example of an area ripe for further study. Consider allowing a signal if the market is in the top N, ranked by ADX, and one of the top two ranked active orders of the day. For example, if the maximum number of positions is five, and we have three of these with active entry orders in the top five, we only would allow the top two to get filled.

We also could consider exiting the trades when a market drops out of the top N, where N is maximum number of positions. Research shows that the quality of trades is better and winning percentage can reach 60% or more using this type of ADX screening filter. The problem is this filter tends to reduce overall returns.

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