Money Management for Potential Profit Strategy

The r - and l -algorithms from Chapter 3 produce a potential profit strategy that properly handles transaction costs and generates the maximum profit and loss (P&L) under the conditions that each trade has the same number of contracts. In this chapter, we will apply the money management results obtained in the previous chapter to a potential profit strategy. The goal is to increase the P&L further under the restriction of a self-financing account, one that does not use capital other than the initial investment and subsequent profits and loss. In order to achieve an increased P&L, we must first be able to trade a greater number of contracts at times recommended by the r – or l–algorithm and within limits allowed by the total equity currently in the account. The second step is to optimally increase positions during the intervals between the times recommended by the r– or l-algorithm as allowed by the increased trading power of the account. Both steps represent a level of P&L optimization based on the total equity and trading power. This optimization achieves the maximum P&L and answers the question: “What is a minimum investment required to achieve a targeted P&L” At this point, we will consider only the results of trading a single market and a portfolio of a single instrument. However, each long or short position may now include several contracts bought or sold at different times and at different prices. This chapter introduces ...

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