Consider Position Sizing When Comparing Systems

Lots of people like to compare systems on the basis of a single contract. However, this can be very misleading. The following examples show you why.

One problem is with the lack of position sizing rules. Often times, two equity curves will be compared and one will show (for example) $1,000,000 in profits and a $30,000 drawdown, while the other shows $1,000,000 in profits with a $50,000 drawdown. On the surface, the first system looks better. However, this can be seriously flawed.

What if the second system had position sizing rules that rejected certain single lot trades if the equity in the account was under a certain amount? For example, "as long as the equity in the account is less than 100k reject all trades with risk greater than $1500". This single rule could completely change the above numbers. Now the second systems might show $800,000 in profits with only a $20,000 drawdown. Now all of the sudden the same system both trading single contracts just flip flopped in their ratios based on one money management rule!

In order to avoid this you need to see results that show the system with all of the applicable position sizing rules applied. Otherwise you may not be seeing the real system at all!

Example System Single Contract:

Net Profit: $788,103
Maximum Drawdown: $77,234
Ratio: 10.20

This example shows a 50k account. To somebody that did not understand position sizing vs. single contracts they may look at this and think "oh my god, a $77,234 drawdown on a 50k account, no way!". However, what they may not realize is that when the account was less than 100k it was supposed to skip trades with risk above $1500. This rule would change the results, see below.

Example System Reject Trades with Risk Above $1500

Net Profit: $547,170
Maximum Drawdown: $33,302
Ratio: 16.4

Here you can already see a big change. Just this simple rule cut the drawdown by more than half and increased the ratio. This is why systems designed with good money management and position sizing rules should never be compared on a single contract basis. Without the position sizing rules factored in its not the real system!

Although, the above example is also flawed because it skipped all trades that were above $1500 in risk no matter how high the equity got. However, it was supposed to stop skipping those trades once the equity got to $100k. Therefore, you need to rerun the test inside a real position sizing based system tester.

Example System with Proper Position sizing applied.

Average Annual Return: 79.2%
Maximum Drawdown: 36.08%

There was no way from the above single contract examples to know what the final outcome was going to be with all of the position sizing applied. Therefore, you MUST see results in a way where all of the money management and position sizing rules have been applied. Some vendors who don't understand this will attempt to compare single contract reports with a system designed with money management. The problem is that the single contract report may not really be the system at all. This is why we give you some comparison reports in what we feel is the proper format (see here).

Until next time,

Dean Hoffman
DHoffman@TradersTech.Net

Risk Disclosures

COMMODITY TRADING involves high risks and you can lose a significant amount of money. Commodity trading is not suitable for many investors. Any performance results listed in all marketing materials represents simulated computer results over past historical data, and not the results of an actual account. All opinions expressed anywhere on this website are only opinions of the author. The information contained here was gathered from sources deemed reliable, however, no claim is made as to its accuracy or content. Different testing platforms can produce slightly different results. Our systems are only recommended for well capitalized and experienced futures traders.

CFTC REQUIRED RISK DISCLOSURE

HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN. IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULAR TRADING PROGRAM.

ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT. IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK IN ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADING PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS AND ALL OF WHICH CAN ADVERSELY AFFECT ACTUAL TRADING RESULTS.