The Successful Trader's Guide to Money Management

CHAPTER 4Money Management Models

In this chapter I'll illustrate some of the most popular money management methods. The approach we've studied up to now using the Kelly formula attempts to adapt to the characteristics of the system, adjusting the amounts of the bets on the basis of purely statistical data on the same. We've already discussed the limits of this method and the possible negative repercussions. When studying different approaches, the tendency is to concentrate on what the consequences of what we decide to do might be. The methods we'll take a look at are based on concepts the aim of which is to consider negative cases and limit their impact. Kelly tried to maximize profits, without worrying about individual transitory events (in fact he focused on how these combined, analyzing the final statistics). Many methods have, however, been developed to attempt to consider the possible effect of every choice made, step‐by‐step. So now there's more focus on the effects of losses and the impact these can have both in terms of global equity, but also psychologically.

Some of the methods we'll take a look at start with the most negative case possible, when the system suffers the worst loss, and on the basis of said data, attempt to adjust the amounts used to enter trades and limit possible negative impact.

These methods have been refined and initiated to consider also combinations of negative events, which generally occur in periods of marked drawdowns. Therefore, considering ...