Nelson F. Freeburg. Portfolio-level Commodity Trading

Источник: Nelson F. Freeburg. PORTFOLIO-LEVEL COMMODITY TRADING. Maximizing Risk-Adjusted gains with Trade Managemet. Formula Research, Volume V, No. 9 (June 21, 1997)

Let's start with a simple trading system to illustrate how money management can affect, even dominate performance. This case study, adapted with permission

from the trading Recipes manual, is particularly revealing. Our system looks for a pattern of weakness and then goes long on an apparent upside reversal.

The setup for a buy signal is two lower lows followed by a higher low. Assume today the setup was satisfied. You enter long on tomorrow's close if two other conditions are met. First, today's close must be above a 28-day simple moving average. Second, tomorrow's open must be greater than today's close. Once long, trail a stop at the lowest low of the past ten days. Short trades are the mirror image of long trades.

We will test this simple system on the four major foreign currencies-Japanese yen, German mark, Swiss franc, and British pound. Our test period is 1984 through 1988. Trading single contracts, the four-market portfolio gained $63,087. All performance figures in this study allow $100 per trade for slippage and commissions.

Suppose you start with a $50,000 account. With just over $63,000 in profits, Recipes reports the compound annual return (CAR) is 18.2%. Recipes treats drawdown as the maximum dip in open equity. You can measure drawdown in terms of percent or actual dollars. Recipes reports both along with their respective dates (which rarely coincide.) Here the drawdown figures are 29% and $22,863. Recipes also tells us the duration of the longest drawdown, in this case 16 months. (This useful statistic reports the longest period in which your account made no new equity high. In effect, this is a third, temporal specification of drawdown.)

Now let's experiment with some trade management tactics. The entry and exit rules remain exactly the same, but we will vary the number of contracts traded. Recall that our exit point for long trade is the lowest low of the past ten days. For short trades the stop is the highest high of the past ten days. Now we can calculate our risk. (Of course, we are only estimating the risk since a gap opening could blow through our stop.) Having a predefined stop is critical to the money management functions of Trading Recipes.

Suppose our system tells us to buy the Swiss franc at today's close. Toward the end of the session we monitor the close and compute the distance to our stop point-the lowest low of the past ten days. We determine that a fill at current prices would expose us to a theoretical maximum loss of $1,500 per contract (including slippage and commissions). How many contracts do we trade?

Well, let's start by limiting the risk per trade to 5% of equity. With $50,000 in account, we have $2,500 to commit to the market. That is enough to purchase one contract (with $1,000 left over). If we limited risk to 2% of equity ($1,000), the trade would be rejected. If we wanted to risk 10% of equity per trade, we could trade three contracts. (See box.)

50,000	*.10	= 5,000
5,000/	1.500	= 3	33
Round	down	to3	contracts

So what happens when we limit exposure to 5% of equity? First, several trading signals are rejected because the risk is too high. Of 136 potential trades, 17 signals were ruled out. As for the trades that were taken, position size varied greatly, from single lots to as many as 25 contracts.

The greater presence in the market had a big impact on the bottom line. Profits doubled to $132,000, CAR of 30%. Unfortunately, drawdown also soared to 48%. The longest equity dip fell only modestly to 16 months. Apparently our efforts at risk-control were not entirely successful.

Another sign of unwelcome risk in our results is that three margin calls were generated. Recipes will mark your position to the market and track margin much like a brokerage firm. (You can adjust the margins used in Recipes' internal calculations. Mine came from my broker, Lind-Waldock.) One way to eliminate margin calls is to cap the percentage of equity allocated to margin. We will size our "bets" so that total margin never exceeds, say, 20% of equity.

Assume we have a $50,000 account. Assume also we are already long one Swiss franc with margin of $1,750. Now we get a buy signal for the British pound, with margin of $1,650. To cap total margin at 20% of our equity, we could trade up to 5 contracts ( [(50,000 * .20) - 1,750] / 1,650 = 5 ). Assume we take the five-lot trade. Our total margin is now $10,000 ( [5 * 1,650] + [1 * 1,750]), exactly 20% of equity.

Back to improving our system. We have two money management filters to work with. We cannot risk more than 5% of equity per trade. And we will limit margin on all open positions to 20% of equity. To be conservative, we will choose whichever formula prescribes the least number of contracts.

Results are very different with these new rules. The margin calls disappear. Drawdown falls from 48% to 38%. And the longest drawdown period was cut in half, from 16 months to 8 months. Clearly risk has receded. Meanwhile, the profit-side of the picture is just as bright. Trading gains actually climbed to $194,000, a 38% annual return.

We can push the envelope further. Now let's risk 10% of equity on each trade. And instead of a 20% cap, up to 50% of our equity is committed to margin. Here the compound annual return soars to 63%. A $50,000 stake grows to $535,000. This is the same system that yielded $63,000 in profits with single contracts! Of course, such returns come at a cost. In this case drawdown climbs to a punishing 62%. But the example underscored how seemingly small adjustments in trade management can drastically affect performance.

2. Zamansky, Leo J., and David Stendahl [1997]. “Dynamic zones,” Technical Analysis of STOCKS & COMMODITIES,
Volume 15: July.