Money Management Experiment

[Matt Bowen]

Here is another great tool on money management... See if you can manage the $10,000. portfolio for 100 trades.

A couple of years ago I was found this website on Google and it has some very good information on money management The site is run by Thomas Pflügl.

http://members.aon.at/tips/moneyManExperiment.htm

I know you guys don't like this money management stuff, but let me tell you something, if you don't learn this stuff now, you are going rack your brain five years from now trying to figure where your money went. :eek:

Just remember: In trading, you're not paid for analyzing charts. You're not paid for calling in the order, What you are paid for is successfully managing the position while you're still in the trade. ;)

I believe this is a good money management site to learn the effects it has on your performance.
http://members.aon.at/tips/moneyMan.htm

All the best,

Matt

[Matt Bowen]

I ran the test using 2% risk per position...

[Matt Bowen]

The money management experiment software is a great tool for learning position sizing. However, it needed a few things in it to make it a really good tool and we added the new R-multiple to the software. In addition, the automatic position sizing number that calculates the number and tells you what to put in on each trade. You can also add Commissions.

The reasons for the changes are very simple. The way the calculator was originally setup you always had an R-multiple of 1 to 1 on each trade (meaning you risk a dollar to make a dollar).

Well, it does not take a genius to figure out that if your win/loss on each trade is 1 to 1 and you have a 40% winning percentage you will drive your trading account into the ground :mad:

By adding the R-Multiple (Win/Loss) to the calculator you can now see that a system that only wins 30% of the time can still make money if the average winner is 3 times greater than the average loser (look at the example):

http://users.adelphia.net/~spoonaz/Win.gif

[Matt Bowen]

What is the "R" multiple??

The money that you can lose in an investment if it goes against you is what I call the "risk amount." Since this risk amount so important, we give this concept of "risk per investment" its own shorthand -- calling it simply "R" (for RISK). We call this the "worst case" loss, because this is the point at which you'll know that the investment didn't work out as planned.

Top investors describe their opportunities in terms of reward to risk ratios. These investing pros think about multiples of their risk amount, or "R Multiples", a concept created by popular trading coach Van K. Tharp. If the investment is likely to make three times the risk amount (or "R"), then the investment is a 3-R opportunity. We can then use this shorthand to describe all of our investments, regardless of whether the investment is in stocks, mutual funds, real estate or any other investment instrument. A 2-R profit means the same thing in stocks as it does in real estate -- you made two times the amount that you risked.

Let's look at a couple of examples of how this would work…

In the first example, you want to buy a house for a bargain price, and you just want to "flip" it (sell it to another buyer) for a quick profit. You make the purchase of an $80,000 home with a predetermined risk amount, R, of $5,000 -- that's the most you're willing to lose on the deal. You hope to sell the property for $100,000, or a $20,000 gain. This would be a 4-R opportunity because your projected profit (of $20,000) is four times larger than R, your risk amount (of $5,000). In our example, the housing market is softer than you expected, and you end up selling the house for $90,000 -- a $10,000 profit. This turned out to be a 2-R investment for you; you made twice what your risked.

Now let's look at a stock example. Microsoft is trading at $25 and your trading strategy says that it is a short-term buy. Your strategy says that if the price drops to $23 you should get out, so R is $2 per share. Remember your risk is $2 per share at the planned exit point. It's not the full value of the stock $25, because you'll be out if it drops by $2. You have a profit target of $33, so your profit potential is $8 or 4-R, four times your risk amount. However, Microsoft's price just can't seem to get above $29, so you decide to take your profits at that price and move on to the next opportunity. Your actual trade turned out to be a 2-R investment, again making twice what your risked.

Hope this helps,

Matt

[Matt Bowen]

Here is a new version of the Money Management Experiment that allows you to control the Risk/Reward of your position size. The previous version simply gives every trade a 1 to 1 Risk/Reward.

Here are the changes to this version:

Risk/Reward can be changed to match that of any trading system's metrics (ex. 2 to 1, 3 to 1, 4 to 1).

Current percentage amount of equity used in each trade based on current account equity of portfolio.

Commission charged for each trade (set commission to deduct on all trades)

http://www.mtptrader.com/MTP.xls

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