Fixed Ratio Money Management

[Pinozi]

Hi Traders,

I'm reading through "Ryan Jones - The Trading Game" and he presents a money management technique called Fixed Ratio Trading. Its a fairly simple formula and seems to help grow small accounts geometrically

Im trying to find some free software on the net that can simulate the trading but most want actual $$$ for it

Just wondering if any keen programmers can fix up a quick spreadsheet that can do the same. The formula is pretty basic and I'll post it here if anyone is keen

Any help is much appreciated

Cheers

Pinozi

[californiajeff]

can you explain his money management technique in further detail?

[birdjaguar]

Hi Traders,

I'm reading through "Ryan Jones - The Trading Game" and he presents a money management technique called Fixed Ratio Trading. Its a fairly simple formula and seems to help grow small accounts geometrically

Im trying to find some free software on the net that can simulate the trading but most want actual $$$ for it

Just wondering if any keen programmers can fix up a quick spreadsheet that can do the same. The formula is pretty basic and I'll post it here if anyone is keen

Any help is much appreciated

Cheers

Pinozi

Excellent book. I am a little surprised more people haven't caught on to it. I downloaded a spreadsheet which essentially uses the same formula some time ago. You will need to change the delta to 1/2 the risk amount to match the book. I use a delta of .618 because the .50 moves too fast for me. You will have to PM me to get it however, since this program doesn't support Excel. Of course you need to be consistently profitable in order for the fixed ratio method to work properly. Also, you will still need to allow the market to tell you when to scale up rather than following the method blindly. You have to consider volatility as you increase contracts. Great choice of material. Good luck with it.

[Pinozi]

I got this off another website and gives you a quick rundown on the technique.

I was referred this book because I have been profitable and want to apply this method so profits increase geometrically - nothing better than playing hard with the markets money!!!

I cant PM you Birdjaguar as I dont have enough posts - but here is my email - pinozi@inthemix.com.au

Cheers

Pinozi








In fixed ratio position sizing the key parameter is the delta. This is the dollar amount of profit per contract to increase the number of contracts by one. A delta of $3,000, for example, means that if you're currently trading one contract, you need to increase your account equity by $3,000 to start trading two contracts. Once you get to two contracts, you need an additional profit of $6,000 to start trading three contracts. At three contracts, you would need an additional profit of $9,000 to start trading four contracts, and so on. For stock trading, a "contract" can be interpreted as a fixed number of shares, such as 100 shares.

Fixed ratio position sizing was developed by Ryan Jones in his book "The Trading Game," John Wiley & Sons, New York, 1999. Based on an equation presented by Jones, it's possible to derive the following equation for the number of contracts in fixed ratio position sizing:

N = 0.5 * [(1 + 8 * P/delta)^0.5 + 1]

where N is the number of contracts, P is the total closed trade profit, and delta is the parameter discussed above. The carat symbol (^) represents exponentiation; that is, the quantity in parentheses is raised to the power of 0.5 (square root).

A few points are worth noting. The profit, P, is the accumulated profit over all trades leading up to the one for which you want to calculate the number of contracts. Consequently, the number of contracts for the first trade is always one because you always start with zero profits (P = 0). Also, as you accrue more profits, the number of contracts increases more slowly. A $10,000 profit made early in a sequence of trades will increase the number of contracts more than a $10,000 profit made after many other profitable trades.

Unlike with fixed fractional trading, the trade risk is not a factor in the fixed ratio equation. All that matters is the accumulated profit and the delta. The delta determines how quickly the contracts are added or subtracted. Also note that the account equity is not a factor. Changing the starting account size, for example, will not change the number of contracts, provided there is enough equity to continue trading.

As an example, consider the series of trades below. The starting account size was $50,000. The profit/loss per contract is shown in the second column ("PL/Contr"). The next column is the trade risk, which is not used in fixed ratio position sizing. The delta was $1500. The next column shows the number of contracts computed according the equation above. Multiplying the number of contracts by the profit/loss per contract results in the position profit/loss ("Pos PL"), which adds to the current equity value to give the new value of account equity, shown in the last column.



Trades and number of contracts in an example of fixed ratio position sizing.

Notice how the number of contracts starts at one and slowly increases as profits accumulate. If a smaller delta had been used, the number of contracts would have increased more quickly but would have dropped more after a loss.

The equity curve and the number of contracts is shown below over a longer span of trades from the same market system. The bar chart, below the equity curve, illustrates how the number of contracts increases with increasing profits.



Equity curve and number of contracts in an example of fixed ratio position sizing.

Because the number of contracts always starts at one, the fixed ratio method usually produces better results for smaller accounts. For larger accounts, it may take an unreasonable amount of time to increase the number of contracts to a level that takes full advantage of the available equity.

[birdjaguar]

Okay Pinozi, I sent the spreadsheet with the formula for the fixed ratio method. It does not include a decreasing method. I will be developing that soon. I just haven't had time. Also, you will want to alter this method if you trade breakouts. As you probably know, the rhythm of breakouts is more like win-lose-lose-lose-win-lose-lose-lose-win. In this case you certainly don't want to scale up after a win. Although it is seen as a gambler's fallacy, if you have noticed breakouts after a certain number of days of consolidation, then that is the time to increase rather than after a win which increases the account followed by several losers. In other words, there are occasions for a martingale approach. If you don't trade breakouts, please disregard but some feedback would be nice for those who might be reading. Happy tradiing.

[ap]

I read this ebook too, and it didn't sound convicing at all,

the author discovers FRMM as a replacement to FFMM because you can not trade fractional contracts in future markets.
but you can do it in stock market and also in FX there are FX brokers who allow based 10 unit lot size, and another one that allows 1 unit lot size.

as far as concerns the formula I never understood why it maximises profits better than FFMM:

It is suposed to be mathematical formula that the author presents yet I didn't find any mathemathical explanation why this formula should work and how it works in different performance condidtions. The author swears that he has done extensive math work with his father in law and since he goes church you can take his word for that. But I didn't see anything in his book except for a lot of printed spreadsheets (people have already invented graphs to better visualise this kind of stuff) as though he did it on purpose to confuse the reader.


For the system to work He says "you have to be profitable". (the first time I read this I was shocked)

No where in the book you can find answer to a "why" arising question

"The key parameter "delta" that is introduced"
I didn't see anywhere how one could set his delta for trading
the only explanation given " agressive - small delta, moderate-big delta" "too big is might be risky to small might be not enough".
Isn't it the same thing to say 1% is to small and 15% to risky in FFMM.

Could someone please compare the results over the same set of trades between FRMM and FMMM I always wanted to do this but I never understood what the author had discovered, besides a substitute to FFMM for an undercapitalised trader in future markets.

I tried to read this ebook three times but I was unable to get through it.
Each effort costed my health 5 packs of cigarettes to get to page 38, and each time I gave up thinking that eitherthis guy is the worst writter on the face of earth or his work is a total mockery.

[birdjaguar]

If you did not like this book, perhaps we can spin off of a book that you did like. Is there a book on increasing contracts that you did like? All of the authors I have read on the subject suggest risking no more than 2%-3% of your account on any one trade. If you are uncomfortable with the fixed ratio method, then stick to this general rule. There is no optimal way. Markets are dynamic and therefore, optimal parameters will change over time.

[ap]

What I'm saying is that I did not understand why fixed ratio is better than fixed fractional once the condidtions allow to use the latter.

[comenow]

I read Jones's book some time ago. It is tricky to understand in what way it is better than a fixed fraction MM method. In terms of how fast it can grow your account, it clearly isn't any better and, in fact FFMM is much better. Why? Assume that you risk 3% per trade and you have £5,000 for trading. Using 3% fixed you risk £150 on the first trade and 3% of any money you have in your account after that. Let's take the different scenarios.

1- You win £300 on the first trade, say. You now risk 3% of 5,300 on the next trade and so on.

2-You lose £150. You now risk 3% of £4,850 on the next trade and so on.

In other words your bet size is adjusted automatically so you bet more when you win and less when you lose in money terms.

Now let's look at the FR method advocated by Jones. Let's say your delta is £1000. So you increase bet size when your account gets to £6000 and every £1000 after that until such time as you change your delta and the increase happens at different points in your equity curve.

Clearly, the trader who compunds after each trade is going to make more money than the person who waits for the effect of the delta to kick in. So, in terms of making more money, the one using FFMM will do better. But there is a snag and that is where it gets interesting.

With FFMM you will suffer from the effect of asymmetrical leverage. Meaning, you will have to make more and more to come back as you have losing trades because you are reducing your bet size after each and every loss. If you have a string of losses, you can find it hard to come back. Whereas, with FRMM, you don't reduce your bet size after every loss. So the amount you have to win back is going to be the same as the amount you lost. This will make a huge difference to your results because consider the following example.

Trader A uses FFMM. He has £5000

Trader B uses FRMM. He also has £5,000

They both use the same system to trade. They started by risking £150 on each trade. They have 6 losses in a row, and as a result lose £900 each. When the losing streak ends, trader A is now risking £123 on each trade, whereas trader B still risks £150 per trader. Just as an example, lets say they are using a 30 pips stop loss on each trade. Trader B will need to win 180 pips to break even whereas trader A needs to win 220 pips to do the same. Over time, trader B will leave trader A far behind because of this asymmetrical leverage.

Some of you must at this point be thinking, trader B is playing with fire because he doesn't know when the losing streak would end, and you would be correct. However, you need to have a good idea of what kind of drawdown you should expect from your system and decide which MM method to use ccording to that.

The only reason anybody should use FRMM is if they:

1- believe that they are going to be held back by asymmetrical leverage and;

2- Have such confidence in their system that they believe the drawdown will not exceed a particular amount.

Like everything else in trading, however, you should consider everything that affects your trading.

[ap]

There you are:

The same trades using Fixed Fractional 2% of capital 1:1 Risk:Reward

FF performs better at least for this set of trades.

[comenow]

There you are:

The same trades using Fixed Fractional 2% of capital 1:1 Risk:Reward

FF performs better at least for this set of trades.

FF will peform better for any set of trades where the drawdown isn't too large.

[Fxexcel]

Both techniques are excellent. The interesting thing about them is that both of them can adapt to any risk profile. For instance in a FFMM you can you can increase you risk from 1% to a 3% per trade. In a FRMM by decreasing the delta, you also increase your risk. I guess the results obtained on each technique will depend on the parameters used.
What is important though is to use one MM technique

Regards
Fxexcel
www.straightforex.com

[Pinozi]

Thanks for that Birdjaguar!!

Cheers

Pinozi

[radicalmoses]

I just thought that I will join in the discussion since this is a very interesting topic for me. I will admit that the book is a little to tedious for me to read as the repetition on the probabilities almost made me want to quit. But in all the concept is definitely great and has the potential to make a great system spectacular. All trading systems deal with potential huges losses and drawdowns. If you are using FFMM it is good but not optimal.
FRMM is the closest you can come to "let your profits run and reduce your losses". I am convinced.
By the way,, since you can adjust your leverage and trade right down to a mini-contract,,, can someone tell me whats the starting capital required so as not to be undercapitalized before starting to trade the FX??
P.S - Can some one pass me the spreadsheet for the FRMM??
This book definitely requires a 3rd reading

[birdjaguar]

What I'm saying is that I did not understand why fixed ratio is better than fixed fractional once the condidtions allow to use the latter.

You understanding is quite correct. The fixed ratio method is not necessarily better once your account grows large enough that you can be content with the fixed fractional method. I think most of the traders here are small traders, which is why some of us have found the fixed ratio method as a great tool to grow the account geometrically. You are going to have to take on greater risk in order to grow a small account. This method is a great way to control that risk while using it to grow. Once you are living comfortably off of your trading account, switching to the fixed fractional method is a good idea. As it has already been posted, both techniques are useful.