CHAPTER 26
Dynamic Ratio Money Management
Tailoring optimal f, TWR, and HPR to our goals brings us back to the importance
of finding the right balance between fand the amount to risk per share, so that we
can make as many trades as possible, in as many markets as possible, wasting as
little time as possible. Frequent short-term trading usually means a rather low
average profit per trade and the use of tight stop losses that make sense in relation
to the estimated and desired average trade length. The drawback is that the short-
er-term the system, the tighter the stops on a one-share basis need to be, and the
tighter the stops, the fewer trades we can be in simultaneously for any given f. The
less we risk per share, the more shares we need to buy to reach f, and the more
shares we need to buy, the more money we need to tie up in the trade.
For example, say that our system calls for a stop loss that is placed only 2
percent away from the entry point, on average. For a $100 stock, this means two
points (100 * 0.02). Further, assume that we don’t want to risk more than 1 per-
cent of our available capital per trade. With $100,000 in available capital, we there-
fore should buy 500 shares of the $100 stock [(100,000 * 0.01) / 2], which will tie
up $50,000 of our capital (500 * 100). As a consequence, we can only be in two
similar trades simultaneously [Integer(100,000 / 50,000)].
Note that it doesn’t matter how much money we have or how much the stock
costs. Given a 2 percent stop loss and an fof 1 percent, we can only be in two
trades simultaneously, no matter the values of the other variables. For example, if
we substitute a $10 stock for a $100 stock and increase the available capital to
$1,000,000, at first glance it seems as if we should be able to be in plenty more
positions at one time. But because the stop loss will be only 20 cents away from
the entry price (10 * 0.02), and the number of shares we need to buy will be 50,000305Copyright 2003 by The McGraw-Hill Companies, Inc. Click Here for Terms of Use.