Jan 152012
 

I did a simulation on excel for increasing 1 contract every 2 weeks.  The results are really encouraging.  I averaged 3 pts/day the past 2 weeks but I use 2 pts/day to be more realistic.

If one starts with a $10k account and uses 2 pt stop, the max risk one would take is 2.22% and if the average loss is $62.50 due to trailing the stop, the avg loss would be max 1.39%.  This comes on week 7 trading 4 contracts.  After that the % risk decreases, meaning one could increase their size by more than 1 lot if they wan to, but I like the idea of having my risk < 1%.

Once one is up to 10 contracts, the monthly income would be $21k which is $251k annually.  After that the numbers go ballistic and get rather unbelievable. By 20 contracts the yearly income would be $500k.

There are a few observations here:

This doesn’t include any kind of drawdown simulation.  Losing weeks may happen.  If so you’re looking at your avg loss times the number of losses you will accept per day (your daily stop limit) times a few days, whatever gets to your weekly loss limit.  If we say 3 stop outs per day and 3 losing days a week that could be 9*1.39% = 10% of your account.  So that’s something to pay attention to.  That would have a big impact on psychology.

If one starts with a larger account size, the % risk would be considerably smaller.  Starting with 20k would put the max risk at 1.58% and max avg risk at 1%.  That extra $10k to start with makes a big difference in your risk.

If one uses a stop larger than 2 pts or an average loss greater than 1.25 pts, then the % risk would be much higher and you’d want to start with more money or increase size more slowly (like once a month instead of every 2 weeks).  For example with a 4 pt stop and starting with $20k your max risk goes over 3%.

If one makes only 1 pt/day, it’s all still possible it just cuts the profits in half (obviously).  The % risk goes up to 3% so one would want to increase size more slowly.

The hardest part is becoming consistently profitable with 1 contract with a well-defined risk.  It doesn’t matter if you average 1 pt a day or 2 or 3.  It doesn’t matter if your stop is 2 pts or 3 or 4.  All that matters is that you’re consistently profitable.  Even a little bit.  Now the consistently part is key because a few weeks or a month isn’t enough to know.  For example in my case I’ve done well so far this year but the market has been relatively quiet.  What will happen when the market gets more volatile?  I expect the winners will be bigger but I may stop out more often (which is the case with the Bund on sim, I was stopped out of many winning trades due to the volatility).  So to know you’re consistent takes a long time.  The last thing you want is to increase size quickly and the market changes and you go into a drawdown.  Drawdowns are really damaging psychologically.  Which is one reason for my rule where if I loose money I will take off at least 1 contract.  In my case I was consistent last year with wider stops so that increases my confidence that I’ll continue being profitable even when volatility picks up.  But it’s not sure.

The next hardest part is getting up to 8 contracts.  After that the % risk continues going down and the 1 contract increase gets proportionally smaller.  With 8 contracts you have a lot of scale opportunities and can keep 1 or 2 on for the major targets.  Everyone agrees you can make more per contract trading 4 or more than you can trading 1.  So theoretically the avg profit/contract will increase as size is added, but to keep it simple I didn’t include that in my simulation.

The final question is this:  After one is trading 8 it gets easier and easier as risk goes down and profits compound and grow exponentially.  What’s the limit?  When does it become hard to get filled?  When is the psychological pressure of risking several thousand on each trade too high?  And does one even need to push the limits this far?  Theoretically, according to this spreadsheet FT & Rob could be trading 200 lots.  But I’m sure there are other factors that will come into play when one gets to trading large size.

I find this simulation very motivating.  Even if my results don’t play out as well as the spreadsheet, I’m confident that the basic ideas of slowly increasing size are correct and it may take longer but in the long run it will work.  I’m positive of it.

Here is the excel file so you can do your own simulation.  Feel free to share your results and your plan.  If you’re not yet consistently profitable, I hope this post has motivated you to achieve this goal.  If you need help, let me know.  I am not an expert at this and my results pale in comparison to many others, but I’ve struggled for a long time and so I know what it’s like and may be able to help.

Excel file: Position Sizing

 

 

 

 

 

  12 Responses to “Position sizing simulation & compounding”

  1. I think that Rob spans between 3 – 30 contracts. I have no idea about FT71 though … given he s probably far better capitalized … oh maybe I dont wanna know 🙂

  2. Interesting analysis but shouldn’t your trade size be more of a factor related to account size? I only trade 1 contract per 25K. So with my ~100K account I am entering with 4 but will add 2 and then add 1 more if the trade continues to move with me. I only add contracts if I maintain the same level of risk at all times. I think if you do the analysis of your past trades you will see that you would have made a lot more profit this way.

  3. Gil – there are a few ways to look at this. For me the % risk is not a problem as I’m trading small (1-2 lots) for my account size. I could calculate the maximum risk I could take and trade the maximum contracts, but psychologically it’s not easy to go from 1-2 to say 4-6. Also if one is not trading all in all out, one needs to make sure their method is scalable. For example with 4 contracts I could go for 4,6,8,10 but if that last target is rarely hit it’d probably make more sense to go 4,6,8 etc. So I believe increasing contracts slowly is the best bet.

    The idea I presented is designed to increase size only after 2 weeks of profits. Those profits will then cushion any shock (drawdown) that comes with the increased size. It allows one to increase size without incurring a lot of risk on the account. in effect you’re “playing with their money” to quote a gambling phrase.

    I added the account $ to find out what the max risk would be for a given account size. I did this in order to show that one can start with only $10k and if consistently profitable they can grow their account exponentially without having a high risk. If one starts with over 20k then the risk is very small. What I showed was the difficulty is in going from 1 contract to around 8. It sounds like you’re already at that point, which merit a congratuations. Getting up to 7 contracts is awesome.

    So for your case, did you start with 100k and 4-7 contracts? or did you start with $25k and 1 contract and slowly grow it? How did you do it?

  4. I started off with 50k so I’ve done ok. I started with 2 contracts and would add 1 if the trade went well. I didn’t start doing better until I started scaling into my positions. I don’t trade with a set target or a set stop but I won’t risk more than 2% on any trade. Often my risk is less since my stops are based on support/resistance areas. My percent profitable is only 35% but my losses are small.

    I can’t wait till I get to 10 contracts and add 5 and add another 2. I think my leverage will be really great then.

  5. Hi Michael,

    Thank you for the post. I downoladed the sheet and played with it, but I have difficulties to understand how you arrived at the avg. loss of 62.50. I see that this corresponds with 5 ES ticks. What is the trailing stop strategy you used for this model?

    Thanks,

    Benko

  6. Hey Benko I often have a 6 tick stop and try to get it to my entry ASAP so I figure sometimes I’ll have zero and sometimes 6-8 ticks. So I figured split the difference of zero and 8 and that gives four and add 1 tick for safety so I used 5 ticks. So far I think that’s accurate.

  7. Thank you Michael!

    Out of curiosity, how much would you normally want the market to move in your favour for you to start moving your stop towards your entry? Also, using this method, what are your thoughts about the “I should have kept my stop where it was” phenomenon in which the mkt stops you out at, say, 4 ticks and then takes off leaving you in the dust, and it never got to your original stop? I know that this is all very subjective but would be interested to hear about your experience.

    Benko

  8. I don’t have a set amount. I generally trail it behind pullbacks so that it’s always a tick or two away from the most recent high/low.

    Today I got stopped out by a few ticks on the bund twice. That will be the subject of my next blog post. 🙂

  9. Thanks Michael, I really appreciate your post in the money management area.

    Benko

  10. COuld you code a position size module in easylanguage?

  11. bomberone1 – I think excel would be easier and more practical if one is not running an automated strategy.

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