Mechanical Trading Systems: Pairing Trader Psychology with Technical Analysis

VOLUMETRIC PRICE RISK MANAGEMENT: MARTINGALE AND ANTI-MARTINGALE STRATEGIES

Stop-loss price risk management is not, in and of itself, a sufficient risk management methodology and should be complemented by a robust system of designating stop-loss levels per volumetric position(s) taken. This two-tiered approach to price risk management allows us to answer these questions: How much I am willing to risk on a per unit basis (stop-loss limit level)? and How many units I am willing to trade on a per account basis (volumetric limit level)?

Although there are infinite varieties of volumetric price risk management strategies, all of them can be broken down into two basic philosophies of position sizing: Martingale and anti-Martingale. Martingale is a method in which the volumetric size of the risks assumed are doubled after every losing trade. The theory is that if we merely continue to double our position size after every loss, eventually we will regain everything lost in addition to the original stake. The problem with Martingale is that a string of consecutive losses will result in bankruptcy. If our beginning position size risked $1,000, 11 consecutive losses utilizing a Martingale strategy would result in a drawdown in account equity of over $1 million. A review of the performance tables 3.9, 3.10, and 4.4 shows that, although a rarity, 11 consecutive losses will occur for some moderately successful trading systems.

Although a “pure” Martingale position sizing methodology is defined ...