From the April 01, 2012 issue of Futures Magazine • Subscribe!

Money management for portfolios: It’s a risk game

Links to the easylanguage codes can be found throughout the following article.

Having a simple, reliable trading system is key to success for those trading one or two contracts. If all goes as planned,  your account will grow. Regardless of how robust that original system is, if you overtrade or take on too much risk, you can blow up. It’s always easier to trade small accounts. The bigger challenge is growing up responsibly.

Most traders have accounts from $10,000 to $50,000. While large enough to support a portfolio of carefully selected markets, the size will restrict you to one contract if you’re operating with reasonable risk control. That restricts your profit and trailing stop options. Often, if trading a portfolio, you may have to skip certain signals if your account size will not allow more positions than funds will support. This gets to the heart of a common problem with portfolio trading. 

If we trade one 30-year Treasury bond futures contract and one Canadian dollar contract, the risk is diametrically different. Consider one measure of risk control: The highest-high in the past 20 bars minus the lowest-low in the past 20 bars. The risk in T-bonds is slightly more than double that of the Canadian dollar, so trading one contract in each market does not balance the risk. This effect gets multiplied across a larger portfolio. 

A basic fundamental fact, but one that’s helpful to keep in mind, is: You cannot apply a money management scheme to a losing strategy and make it a winning strategy. Consider a losing system that has a 50/50 chance of winning but must pay 1% commission on each trade. No risk management method will make this a winner. 

Of course, real-world trading systems are much more complicated than our example. We must estimate such performance metrics to judge how robust a system is and predict how it will perform in the future. That prediction must have a positive expectation, including the effects of slippage, commissions and rollover costs on futures contracts.

All of these considerations affect the trade-sizing methods that we employ. These techniques also must take into account win/loss ratios and the realities of funding, among other key factors.

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