Money Management Using Simulation And
by Bob Pelletier
Here's how to determine your trading system's minimum capital requirements and discover how market
exposure should be modified to maximize profits without increasing risk. Bob Pelletier explains.
Any successful trading system must offer good timing signals, but timing alone does not guarantee
profitable results. While good timing is essential, the addition of key money management techniques
fashioned through mathematical manipulation can mean the difference between moderate success and the
accumulation of true wealth. To succeed in the markets, a trader must use a combination of good timing,
knowledge of required capital and optimal investment levels before entering each trade.
Techniques for timing market entry and exit points are as varied as trader personality and attitude. It
suffices to say that trades should be based on a timing system that has demonstrated a positive
mathematical expectation. Often, trading systems show immense profits on paper that are not reflected
when real dollars are involved. As a result, traders have found themselves asking, "How can I be losing
money with such a profitable system?" The discrepancy between hindsight analysis and real-time trading
results has plagued technicians for years; the reason for it usually involves favorable actual experience
that cannot be sustained or excessive process control in simulated trading. Process control in a trading
system is explained by the number of parameters or rules used in developing the system, and excessive
process control can produce misleading results. For my purposes, a parameter is any quantifiable rule or control mechanism that is consistently applied to timing. I assume that each parameter has been
exhaustively tested to verify optimal settings. Excessive process control is the introduction of too many
parameters in a trading system relative to the number of simulated (or actual) trades.