PART FOUR
Money Management
Ironically, chances are that the less sure a trader is that the next trade will be a
winner, the better the trading strategy or the system. It sounds strange, but there
are two ways to think about this paradox so that it makes sense.
One way is to assume that the markets are as close to random as they possi-
bly can be. Therefore, a strategy that works in a close-to-random environment
needs to be robust enough to maximize the potential of any nonrandom market
behavior when it appears, while still keeping you in the game when the market is
random. In other words, the best you can hope for is a strategy that can turn a prof-
it under the worst of long-term circumstances (randomness).
Hence, most trades signaled by a system, whether they turn out to be winners
or losers, are because of random market moves; only a few trades, scattered among
all the signaled trades, are actually because of the type of nonrandomness the sys-
tem tries to catch. The trick is to make the most of the latter category of trades while
breaking even or just barely producing a profit on all others. Unfortunately, how-
ever, there is no way to distinguish one type of trade from the other beforehand.
The second way is to look at the system as a tool with which we can soak up
and make use of the information the market gives us. If we were only trading on
random noise, the trades and the result would be random. If we were trading on
sure deterministic facts, the outcome of all trades would be certain. When we
make use of the information the market gives us, we’re taking the information
from the market and planting it into the system or trading model. The more infor-
mation we take from the market, the less information is left to make use of, up
until the point there is only random market noise left. The more random noise is
left in relation to unused information, the closer to random the strategy will
behave, which ties back to our first way of thinking.Copyright 2003 by The McGraw-Hill Companies, Inc. Click Here for Terms of Use.