Proper use of open, closed, and hybrid trade equity?

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C3PO
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Proper use of open, closed, and hybrid trade equity?

Post by C3PO »

Hello,

I have read a few posts on applying fixed fraction position sizing to either open trade equity (OTE), closed trade equity (CTE), or hybrid trade equity (HTE). However, I wanted to ask how this is used in practice. In the example below, it seems that the equity under all 3 methods will be the same by the time you put on the next trade. Can someone please look at my numbers below and tell me if there's sonething I'm doing incorrectly? Maybe I am misunderstanding their definitions. I apologize if the table is formatted poorly, I do not know how to make it neater here.


OTE CTE HTE Description
1,000,000 1,000,000 1,000,000 Start
950,000 1,000,000 900,000 Day 1 - not stopped out
900,000 900,000 900,000 Day 2 - stopped out

90,000 90,000 90,000 $risk on next trade at this point

1,200,000 900,000 1,080,000 Day 3 - keep position
1,200,000 1,200,000 1,200,000 Day 4 - exit signal reached, exit position

120,000 120,000 120,000 $risk on next trade at this point



Thanks.
ksberg
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Trade Equity

Post by ksberg »

The example you gave is serial (one market, one position). In this case you will never use OTE or HTE because they are equal to CTE. If you add markets to the portfolio then OTE and HTE make a difference since you will be entering positions in market B while holding a position in market A. Then the question becomes: how much of the open profits in position A should I include in my equity calculations for the next position?

Cheers,

Kevin
C3PO
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Joined: Thu Oct 14, 2004 11:01 am

Post by C3PO »

Thanks for the reply. I was hoping that someone would confirm that my example is only a one market one position game, because I wanted to follow up with a question about diversification with fixed fraction.

If I understand correctly, the purpose of using a fixed fraction is to achieve an optimal bet size. Say for example the formula you're using tells you your optimal fixed fraction is 25%. However, this is too high, and from what I read most people seem to then bring their percentage down to around 2%.

My first question is this: 25% may be too dangerous, but isn't 2% so far away from your optimal that it defeats the purpose of fixed fraction (which is to find an optimal bet size)?

My Second Question:
Say I am in only 1 market and I have $1,000,000 starting capital. My parameters for market #1 says I should use a fixed fraction of 2% on each trade. Below are my bet sizes if I lose the first trade.

First Trade: $20,000 [$1,000,000*2%]
Lost first trade, so my equity is now $980,000.
Second trade: $19,600 [$980,000*2%]

Now suppose I was in 2 markets instead of just 1. Below are my bet sizes for each market if I lose the first trade.

First trades: $20,000 $20,000
Lost first trades for both market, so my equity is now $960,000
Second trades: $19,200 $19,200 [$960,000*2%]

Notice that the bet size for the second trade is now less ($19,200<$19,600). It is less because the "market #2 game" is affecting the equity base of the "market #1 game". Doesn't this mean that you're not really betting a fixed fraction of 2% anymore for market #1? In other words, your parameters for market #1 say to bet 2% for each trade. However, because market #2 affected the equity base of market #1 after the first trade, the bet size for market #1 is no longer 2% of equity on the second trade. It ought to be $19,600 [2%*$980,000], but the effects of market#2 made it $19,200 [2%*960,000].



Lastly, can you please confirm that the 1,080,000 number is correct for Day 3 under HTE? The reason I want to make sure is because my math for this number [1,200,000 - 10%*1,200,000] doesn't seem to be the same math that "Kiwi" was using in this post:

Sun May 18, 2003 4:22pm
viewtopic.php?t=60&postdays=0&postorder=asc&start=0

If I understand Kiwi's math correctly, I would get 1,100,000 [1,200,000 - 100,000] instead of 1,080,000.

Thanks so much.
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