Applying this kind of money management means we always make use
of our winnings from the previous trade, which is why all HPRs are multi-
plied with each other when calculating the TWR and why two trades that pro-
duce a profit of 2.5 percent each produce a total profit of slightly more than
5 percent.
For example, if your initial capital is $100,000 and you make 2.5 percent per
trade on two consecutive trades, your total profit will be $5,063. The $2,500 prof-
it on the first trade would be added to your capital, and you’d make $2,563 on the
second trade (102,500 * 0.025).
Two main points of criticism of this version of the optimal fformula arise.
First, the better the underlying buy and sell decisions, the higher the optimal f. The
higher the optimal f, the more you stand to lose in a losing trade, simply because
the formula tells you to risk more. Some would say that this makes fixed fraction-
al trading too risky for any practical purposes.
Second, to keep the fractional risk amount constant, the dollar amount risked
will vary with the account size. For large accounts, this can translate into enor-
mous and very uncomfortable amounts of dollars risked. For small accounts, theCHAPTER 25 Fixed Fractional Trading 299
FIGURE 25.3
Equity versus optimal f.