A trader\'s money management system

P1: PIC/b P2: c/d QC: e/f T1: g
c09 JWBK182-McDowell April 25, 2008 16:7 Printer: Yet to come

Using Risk-of-Ruin Tables and the OptimalfFormula 81

This gives a value of .025 forf, or 2.5 percent is the optimal percentage of

your trading account to risk on a trade based on this performance data and

the optimalfformula.

COMPARING OPTIMALf EQUATION

RESULTS TO THE RISK-OF-RUIN TABLES

Optimalfequation results give you a higher risk percentage than the risk-

of-ruin tables do when striving for a 0 percent likely chance of ruin. Let’s

look at the following example:

 fis the unknown quantity (the optimal percentage to be risked).


 Ais an average payoff ratio of 2 to 1.


 pis an average win ratio of 40 percent winning trades.

The equation looks like this:

f=

[(2+1)× 0 .40]− 1

2

=

1. 2 − 1

2

=

. 2
2

=. 10

In this example, the optimalfformula calculates that for a trader with

a payoff ratio of 2 to 1 and a win ratio of 40 percent winning trades, the

optimal amount of capital to risk is 10 percent. When we refer to Table

9.1 we see Balsara’s calculation for this scenario gives us a risk-of-ruin

probability of 14.3 percent, which is a small risk butnota zero probable

risk.

Using the optimalfformula, you should understand that it does not

calculate a risk percentage that gives you a 0 percent probability of ruin.

It is a more aggressive approach than when using the ROR tables. When

using the ROR tables you can select a percent to risk that gives you a

0 percent probability of ruin.

ACCOUNT DRAWDOWN

Having equity drawdown in trading is normal, and drawdown is what

causes the novice trader to be ruined because the novice trader has not

yet learned the art of stop-loss exits, position sizing, and controlling the

percent of their account that is risked on each trade.