## How to Select the Best Trading System - Part 2

cleaner Posted 15 Oct. in #Money Management #Trading Systems #Position ManagementLet’s apply Kelley’s formula to the above 3 examples with PE =0.39; 0.56 and 1.13

Example 1

Average win: $152

Average loss: $123

Profitable Trades: 62%

А = W/L = 153/123 = 1.24

PE = 0.39

K = PE/A = 0.39/1.24 = 0.3145

K = 0.31 this gives you a percentage of how much of your capital should be behind each and every trade. In our case, this is about 32%. If we start the Dukas contest with $ 100, 000 then we can risk 100000 * 32% = $ 32 000

If we trade EUR/USD where margin is $ 1,300

$ 32,000 / $ 1,300 = 25 lots where 1pip is equal to $10. At Dukas platform 2.5

I. How to use the Money Management Formula.

As I mentioned in the beginning it is not necessary to be a mathematician and remember all the formulas that we will encountered in the article. I have prepared the Money Management Calculator for you (it's as easy to use as a regular calculator). With it we can easily not only select the system with PE, but also apply the adequate money management process to that system.

What gives us the calculator?

1). Positive expectation of the system that we test (A good system is one that has a PE> 0.5).

2). The percentage of our capital, that should be behind each and every trade.

3). How many lots to trade.

The Calculator has the following fields:

W - Here we have to enter average winning trades

L - Here we have to enter the average losing trades

V - Here we have to enter the percent winning trades

ACCOUNT – here we have to enter the size of our account

MARGIN – here we have to enter the size of the margin for the currency that we want to trade

PE - In this field you can see the calculated result of the positive expectation.

K - Here you can see the percentage of how much of your capital should be behind each and every trade.

A - Here you can see how many dollars you will get back for every dollar you risk.

AMOUNT (millions) - Here you can see the calculated amount (millions) that we can trade with the Dukas platform.

Let us now consider the last two examples using our Money Management Calculator.

Example 1

In window W we put 5615

In window L we put 2139

In window V we put into 43%

In window ACCOUNT we put 100 0000

In window MARGIN we put $1,300 (margin for EUR / USD)

The Calculator gives us the following results:

Our trade system currently has PE = 0.56

К = 0.21

A = 2.63

AMOUNT (millions) = 1.65

Example 2

In window W we put 235

In window L we put 124

In window V we put 73.6

In window ACCOUNT we put $100,000

In window MARGIN we put $1.300 (margin for EUR / USD)

Calculator gives us the following results:

Our traditional system currently has PE = 1.13

К = 0.6

A = 1.9

AMOUNT (millions) = 4.59

I personally prefer not to trade the amount 4.59 with one pair. I prefer to split it into 4 different pairs each equal to 1.15, significantly reducing the risk.

Of course you could use a 2% - 3% rule or any other anti marginal Money Management method.

But, in any case with the Kelley formula, you will know the positive expectation of your trade system and what percentage of your capital is behind you on your next Trade.

II. Determining the size of our account

The question is what is the proper amount to start a trading account with and still be able to apply adequate money management principles?

There is no standard answer to this question, but there is a logical minimum for the size of this amount.

Let‘s considers three factors that determine the size of the account:

- The amount of Drawdown. (Drawdown is defined as the lowest point between two equity highs until new highs are made).
- The amount of margin. For example = $ 1,250 for EUR/USD
- (A margin requirement is simply an amount of money required for collateral to place a trade).
- The third factor is the ability to continue trading even after realizing the expected Drawdown.

So, let's start building our account. Account = Draw Down + 4 times margin.

Why a 4 times margin? To complete the third condition - the ability to continue trading even after realizing the expected Drawdown. It gives us some room for error in the drawdown expectation. If the drawdown is $5000 and Margin $1250 than:

ACCOUNT = DRAWDOWN + 4х MARGIN = $5,000 + 4х $1,250 = $ 5,000 + $ 5,000 = $ 10,000.

But if you cannot start with the $ 10,000 you can start with $ 1,000. Then 1 pip = $ 0.1

Drawdown + 4 times margin do several things. First, it allow us to stay in the game should our system or trading method fail to meet our profit expectations. We can regroup, reevaluate, and continue trading what we are currently trading, or change methods.

Second, it gives us the psychological ability to take all trades, even while we are in a drawdown.

The third thing that is gained from Drawdown + 4 times Margin is that it gives a cushion for error if we erroneously calculated the expected drawdown to be $5,000 when it should actually be expected at $10,000; this precaution keeps us from blowing ourselves out of the game.

And, one more thing for the Drawdown: The Drawdown is 100% unpredictable. But, in having a system with positive expectations, we can apply adequate money management. In this way, we are able to control it. Not to predict it. But, when Drawdown starts to threaten our account, the Money Management reduces its impact and eventually stops it.