Why You Should Include Money Management Feedback in Your System Development
When I first started to develop trading systems, I used total profit or average profit-per-trade as development performance metrics; I never looked at draw-down during the development process. When the system was finished I’d wrap money management around it and then judge how good it was. As you can see from the last three chapters, I now prefer to include a simple form of money management in each step of the development process, and my development metric is average profit-per-year divided by average max draw-down per year—the gain-to-pain ratio. Using this process, I know from the start whether the system is tradeable from a risk/reward point of view. Additionally, I don’t have to go back during the money management process and see which system element is helping or hurting risk; I’ve found that out in the development process.
The major advantage of incorporating money management in each step is a better risk-to-reward system. But a side effect is that you can directly compare any type of system against any other with their respective gain-to-pain numbers. You can’t do that using total profit and profit-per-trade metrics. With those metrics there’s no way to compare longer-term, shorter-term, or scalping systems, and you certainly can’t compare commodity, stock, and FX systems.
In this chapter, we’ll go through an abbreviated version of the development process on our stock system and commodity ...