System design, part X: Exploring money management

By Active Trader Staff
Money management, many people say — often reflexively — is more important to trading system performance than the buy and sell signals themselves. Perhaps that’s true, but you certainly need both, and good money management won’t turn losing signals into winners. At this stage in our system-design project, we have signals that appear, at least historically, to have favorable odds of turning a profit, if not in spectacular fashion.

What we haven’t considered is money management — how to size trades. The system has been designed and tested on daily price data in the S&P 500 Depositary Receipts (SPY) using a static 100-share trade size. While this might seen consistent, it’s actually not, because fluctuating prices results in each position having a different value. This month, we look at what happens with a “fixed-percentage” money-management approach that “normalizes” the position size from trade to trade by varying the number of shares based on the current account equity and stock price.

Comparison trading
The following analysis is based on 140 trades from May 1993 to August 2003 in the S&P 500 Depositary Receipts (SPY) using the “plain” (non-dynamic) version of the system. Table 1 summarizes the system’s performance during this period using the fixed 100-share trade size. The starting account size was $25,000 and $10 per trade was deducted for commissions and slippage.



The precise version of the system — or it’s performance — isn’t critical here, as our interest is what happens when we switch from trading a fixed number of shares per signal to trading a fixed percentage of account equity per signal. The latter approach’s logic is very simple. Table 2 shows the result of the final 10 trades, a roughly eight-month period with six winning trades and four losers — which is roughly representative of the system’s winning percentage as a whole. (The entire trade list will be available at www.activetradermag.com > Web Only > Article Follow-ups between Feb. 8 and Feb. 28, 2009.) The P/L in the final column reflects the gross per-trade return (i.e., without commission costs, which will be the case with all subsequent data in the article) of trading 100 shares per signal.




For the complete article, see the March 2010 issue of Active Trader magazine. Click here to subscribe.



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