Furthermore, even though we might not risk as much as 25 percent per trade,
which assures that we will go broke eventually, we still run a larger risk of going
broke if we risk slightly more than the optimal f, compared to risking slightly less
than the optimal f. The more we risk, the larger the price swings—both good and
bad—and the larger the swings, the greater the risk that one of the swings to come
will be too large to handle. Figure 25.3 shows how the equity varies with different
fs. As you can see, the lower the f, the smoother the equity curve and the smaller
the drawdowns, but also the slower the equity growth. On the other hand, the larg-
er the f, the faster the equity growth—up to a point—but also the deeper the draw-
downs and the corresponding time it will take to recover from them.
A simple example can further explain the formulas for TWR and HPR.
Assume that we already found optimal fto be 0.05, which means that we should
risk 5 percent of our equity per trade. Suppose also that our worst historical loser
was $10,000 and that we have two trades that each produced a profit of $5,000 on
a constant-shares basis. In that case, each HPR comes out to 1.025 [1 0.05 *
(5,000 / 10,000)] and the TWR comes out to 1.0506, which equals a total return of
5.06 percent on total equity going into the trading sequence.
298 PART 4 Money Management
FIGURE 25.2
TWR relative to f in a random trading run.