Using Partial Exits And Position Sizing To Improve Performance Results
One of the most difficult
questions facing traders is how and when to exit a winning trade.
Exiting losing trades can be more straightforward because most traders
understand the importance of preserving capital and cutting losses short.
However, the more difficult exits are those where there is a large amount of
open trade profit. To exit early would risk missing a bigger gain, to exit late
means giving back a large percentage of your current profit. Both of these
options seem to be equally painful in the minds of traders.
One alternative to this
dilemma is to have the best of both worlds. Specifically, using partial exits to
scale out of winning trades. This approach allows you to lock in profits while
simultaneously letting profits run. You may think “yes, but that means multiple
contracts and possibly more riskâ€. However, in this article we will show you how
trading multiple contracts with partial exits and proper position sizing can
potentially reduce risk and improve performance ratios.
We will start out with a simple long-term trend following
system and watch how the performance ratios rise step-by-step as we first add
partial exits and then position sizing. The test was conducted on a 21-market
portfolio over 10 years of data using $75 slippage and commissions. All markets
were tested with identical rules and parameters and a starting balance of
$100,000 was assumed.
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If we didn’t change any of
the exits and just simply traded 2 contracts instead of one then you would just
multiple the profits and losses times 2 and end up with the same performance
ratio. However, in the next test we are going to add a second contract to every
trade but we will use partial exits to scale out of winning trades. What you
will see is an amazing phenomenon; instead of a one-to-one increase in profits
and drawdowns net profits increased by $470,671 yet the drawdown only increased
by $8,511!
Figure 2 shows the same system trading two contracts with
partial exits.
Figure 2
Net profit: $1,143,978
Max $ Drawdown: $69,015
Percentage winners: 38%
Avg. $Win to Avg. $Loss: 3.75
Net Profit/Max Drawdown
Ratio: 16.57
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Figure 3 shows the same system trading a variable number
of contracts based on a $3000 weighting with partial exits.
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Here you can see the amazing
jump in performance. Profits are over 100% higher than in the single contract
test AND the maximum drawdown actually decreased! In addition, the equity curve
is much smoother.
In our final test we will use Trading Recipes software to
compound growth. We will show a $100,000 account risking 2% of equity per trade.
One of the reasons for showing this is to dispel some commonly held beliefs
about single contract performances. For example, the above example shows a
maximum drawdown of $51,445. Therefore, some trader’s might think that a
$100,000 account experienced as much as a 51.44% drawdown. However, this is not
the case. As you will see, the maximum drawdown when risking 2% of equity per
trade was only 26.6% not 51.4%.
Also, just showing the ratio of dollar gains
divided by dollar drawdowns is very limited because most often, just
simply going back further in time will raise that ratio. For this reason (and
many others) its better to look at the percentage gains vs. the
percentage drawdowns.
Figure 4 shows the same system risking 2% of equity per
trade with partial exits and a $100,000 starting account.
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Summary
What these tests show is
that single contract performance results can go through a complete metamorphous
when partial exits and position sizing are added. We started out with a single
contract system that made $673,307 with a $60,504 drawdown. By adding partial
exits and equal weighting we turned it into a system that made $1,377,451 with a
$51,445 drawdown. Furthermore, we showed you how only risking a percentage of
equity per trade and compounding growth could give you a completely different
perspective of the percentage returns and drawdowns.
Hopefully, this will help to
stimulate your thinking about what’s possible when you add partial exits, equal
weighting and position sizing to your trading approach. It’s important to note
that not all systems have performance increases when adding the above
strategies. In fact, some of them actually see a large performance decrease.
Therefore, it’s important not to make any assumptions but rather to see the
actual test results before applying these concepts.
Dean Hoffman
deanh@tradingmarkets.com
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.