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Modeling Trading System Performance

A question often heard around traders is how to best make trading a business. What do you need to have your trading account grow from, say, $100,000 to several million dollars?

Because of year to year variations in rates of return and drawdown, it is risky to count on trading to generate monthly profits. Throughout this book, we will focus on growth of the trading account.

The Trading accounT How much money is in my trading account now?

How much of my assets am I willing to use to fund trading positions? Call that the “active” portion. The remainder will be inactive, and will not be at risk. Drawdowns will be measured relative to the active por- tion and the equity it generates. A trader might have a combination of cash, real estate, collectibles, and retirement funds totaling $500,000, with $100,000 of that in the trading account.

What is my monetary goal, and in how much time? The trader might have a goal of building the $100,000 into $1,000,000 in four years.

What size of loss will cause me to stop trading? Losses can be mea- sured as a portion of initial equity or of highest equity. If the limit is 40%, and based on initial equity, the trader will continue as long as the funds in the active trading account remain above $60,000. If the limit is 40%, and based on highest equity, the trader will continue as long as funds remain above 60% of the highest equity. Equity and drawdown can be computed on either a closed trade basis or an intra-trade (or open trade) basis.

The Trading SySTem

Modeling Trading System Performance (MTSP) is a sequel to Quantitative Trading Systems (QTS). QTS explained the process of the design, testing, and validation of trading systems. In MTS , we are not concerned with the system itself – only the trades that result from it.

You can test any list of trade results, including actual trades, out-of- sample test results, or hypothetical results, but in order for the trading account to grow the system must be profitable (have a positive math- ematical expectation) in the future.

Copyright © 2011 by Howard Bandy All rights reserved This document is a chapter of “Modeling Trading System Performance” Published by Blue Owl Press, Inc. www.modelingtradingsystemperformance.com

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