V.10:4 (135-141): Money Management Using Simulation And Chaos by Bob Pelletier

Money Management Using Simulation And Chaos 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.