Money Management
- We can use stochastic exit mechanisms to reduce the uncontrollable and po-
tentially adverse effects of the win percentage and win/loss distribution (ap-
plying the WCS Principle). - We can use unique risksizing techniques like pseudo‐martingales (i.e., fixed‐
risk martingales) to derive the same earning power without increasing the
percentage or absolute dollar risk. - We can use backtested data to statistically optimize our stopsizing so that we
may attempt to maximize our profit potential. - We can use unique tradesizing techniques to optimize our exposure so that we
can maximize our profit potential.
Money management can turn a winning system into an outperforming and
extremely profitable system. In some cases, money management can even trans-
form a losing system into a profitable system. In the worst‐case scenario, money
management helps reduce the rate of loss and thereby give the system a chance to
recover to profitability. But money management cannot transform a losing system
into a winning system when every trade is a losing trade.the Minefield analogy of Money Management
Let us assume that we are forced to traverse a minefield. It would therefore be in
our best interests to avoid stepping on any mines as we move from one end to the
other. One way to achieve this is to try to predict where the mines are located.
This is akin to using technical analysis. But there are other decisions that we can
make that will make a real difference and actually help reduce risk without trying
to predict where the mines are buried. We could:■ (^) Take the shortest path.
■ (^) Take the least number of steps.
■ (^) Take lighter steps.
■ (^) Take the path of a previous explosion.
■ (^) Refuse to take any steps.
■ (^) Wear protective gear to reduce potential damage.
We observe that these approaches each address the problem from a different
perspective without trying to forecast where the mines may be located. This is akin
to using money management in trading. Another factor that traders need to ad-
dress is the number of trade units or trade opportunities afforded to them. A trader
who risks 20 percent of his or her original capital per trade has only five trade
opportunities to succeed, whereas a trader who risks 1 percent has 100 trade op-
portunities to succeed. Technical analysis plays a lesser role for systems that have
fewer trade opportunities, as it is not provided with sufficient opportunities to al-
low any technical edges or advantages to have a favorable impact on the system.
risk of ruin
Risk of ruin (ROR) is the probability that the account equity will decline to a level
that the trader regards as catastrophic. This level of catastrophic loss is therefore