As demonstrated in my Posedion Strategy Rules and Test Rules article, Poseidon is a trading strategy which gives you an edge. I believe this edge could be further exploited to get better income by using proper money management. For this reason, money management can be the philosopher's stone.
In this article, I will like to explain money management by risking specific percentage of your account, why testing with standard lot can be deceiving and we will be revisiting Poseidon trading system result in the light of issues mentioned in this article.
At the end of this article, I also will explain my thoughts on further development and optimization of Poseidon.
- MONEY MANAGEMENT
There are various formulas and ways to implement money management. In this article, I will explain basic money management. I will only explain using standard fixed lots and risking specific percentage.
Also bear in mind that, there are many more money managements systems like famous martingale and my favourite Kelly formula, but these should be explained in a separate article.
1. Using standard lot size
Most the trading strategies are tested using standard lot sizes by new traders. This means in every transaction we use a standard fixed lot regardless of our equity.
2. Calculating and risking a percentage of your equity
I believe using a standard lot size is deceptive. I do not use same size of lots every time I open a position. I risk a percentage of my equity. Here is the formula.
Risked amount = Account Equity*Equity Percent (which I am willing to risk.)
Lot size= Risked amount / (stop loss distance*pip value)
Let’s assume in a particular trade,
- My stop loss is 100 pips away from the entry price.
- Every pips generates 10 USD with standard lot in the pair I wish to trade and
- I have 10.000 USD Equity and I willing to risk %1 of account in a trade.
10.000* 0.01= 100 (Risked Amount)
100/(100*10) = 0.1 (is the lot size which I should use in that particular trade.)
3. Why I believe using a fixed lot size in test results is deceiving?
I believe testing with fixed lot size is very deceiving because;
3.a Drawdown is not tested properly and even though you test the same period depending your starting date % percentage drawdown varies.
For example in the start if you achieve 6 losses it means you can achieve %60 percent drawdown, you can think the strategy is not working.
10.000 USD - 6.000 USD = 4.000 USD Equity. It can be conceived as this strategy is not working from the start and it flawed.
However same happens after your testing equity reaches 40.000 USD and you experience drawdown of 6.000 USD, it does not bother that much. This seems to be case for the most of the testing reports as well, in the former testing report will say maximum drawdown percentage of %60 and the latter case it will report maximum drawdown percentage of %15.
On the other hand, if I were to use fixed percentage each and every losing trade would have same effect on my trading account. Drawdown percentage in my reporting would not be changing due to my starting date. I would only depend on the market strategy’s performance itself.
For the same reason, it reduces your profitability because as you earn money profitability seems to get lower because ratio between equity and risked amount is getting smaller. You start by risking %10 percent of your account and as the strategy earns money the risked amount lessens.
The reason behind failure to understand the profitability and drawdowns is that standard lot size has no relation with your equity size. You should not neglect your equity amount when employing any money management.
3.b If your are not employing a specific money management method like a version of martingale method, using standard lot size is logically flawed because you are increasing your risk percentage when you are losing and decreasing your risk when strategy is working.
For example if you have starting capital of 10.000 USD you are using 1 standard lot for testing. Let assume you have chance to lose all your margin (1000 USD) in each transaction. This means that you are risking %10 in each transaction.
Scenario 1 you lost 1000 USD. Now your risking 1000 USD but your equity is 9.000 USD. Your risk per trade is approximately %11 and you are risking more for a losing system.
Scenario 2 you gained 1000 USD. Now your risking 1000 USD and your equity is 11.000 USD. Your risk per trade is approximately %9 and you are risking less for a winning system.
- REVISITING RESULTS OF POSEDION SYSTEM
Now, I will re-demonstrate my results from Posedion risking %3 percent in every transaction. I use 0.5 ATR stop loss and 1.5 Trailing Stop as explained in the previous article. This time I also added USDCHF pair with EURUSD, USDCAD, AUDUSD and GBPUSD pairs. Now every transaction has same effect on percentage increase and decrease of the tested equity.
- FURTHER DEVELOPMENT AND OPTIMIZATION IDEAS FOR POSEDION
Lastly, the most important questions not answered here, are i) how much percentage we should risk in each trade and ii) should we use the same ATR values as provided in examples.
Percentage you risk should be based on your principles and it should not be random. Money management is important as much as your strategy. Money management should not be used too aggressive or an unforeseen drawdown can sink your equity or ruin psychology.
I am still working on the Posedion so that I can only explain basically my way of optimization to give you an idea, but it is far from complete.
My basic optimization guidelines;
In my procedure, I test with every possible ATR combination with stop loss 0.1-1 ATR begin stop and 1-3 ATR trailing stop values with %5 money management. I risk %5 in each trade to see if the strategy holds in more harsher terms.
I look for stable zone with darker green values.
Here is USDCHF optimization results by profit. Green areas are profitable and darker the green more profitable area it is.
I retest to see optimization graph with drawdown, profit factor, and expected pay off values.
I always look for good neighbouring zones to confirm combination's reliability. I ignore random spikes and lucky combination.
Other charts of USDCHF optimization
- drawdown percentage
- expected payoff
In this stage the question to be answered how much percentage we should risk in each trade in this pair with this strategy. This all depends on your portfolio.
The only think I can say is, look how many green combination is in the optimization profit map regardless of the chosen ATR combination. More green the graph, I believe the strategy is more reliable in that pair. I risk more in that pair than other pair which has lesser winning combination in total.
Here are the values ATR combination that I use in my live trading. Use it with your own discretion.
- FINAL WORDS
I provided the Expert Advisor of Posedion for Metatrader 4, please use it to do your own testing. You can find the files in the forum and I am planning webinars on the subject. If you have any ideas or questions I would greatly appreciate. For now, I am suspending Posedion article series until I finish my research. Thanks everyone for their support.