Leverage and You

Discussions about Money Management and Risk Control.
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damian
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Leverage and You

Post by damian » Thu Jun 03, 2004 10:05 am

This is a potentially pointless exercise in understanding the interaction or lack there of between the following:

- traders’ risk inclination,
- leverage in futures trading,
- synthetic physical positions.

Consider the following on a generic long term trend following system, just like aberration for example. You have an entry order signalled for light crude oil futures traded on NYMEX:

- buy at $30 stop, if filled place stop loss order to sell at $27.

- the theoretical expected risk on this trade is $3

- you have capital of $30,000

- you position size using a fixed fractional method that references the initial open risk ($30-$27)

- light crude is the only market that you trade.

- you apply your own preference for risk per trade.

:?: Is capital of $30,000 enough for you to take this trade :?:

My answer is no, what is yours? (if you don’t mind me asking).
Last edited by damian on Thu Jun 03, 2004 10:21 am, edited 1 time in total.

damian
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Post by damian » Thu Jun 03, 2004 10:20 am

Needless top say my above poll has some formatting issues that I cant fix now that it is posted. Dan/c.f..... could you delete the additional "yes" and "no" options.

Bondtrader
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Post by Bondtrader » Thu Jun 03, 2004 12:45 pm

Crude is $30 per barrel, the contract is for 1,000 barrels, so at the current price, each contract represents $30,000 worth of crude oil.

You have exactly $30,000 in your account. You only trade this one market. So if you decide to trade 1 contract, you've got an unleveraged position: $30,000 in your account, controls $30,000 worth of crude.

If the position goes against you, you could lose $3,000 per contract. If you decide to trade 1 contract, that's 10 percent of your account.

Nothing is stated about what you stand to gain if the position goes for you, except that it's a typical longterm trend following system. Probably that means 40% wins, avgwin/avgloss = 3.0.

For 1 contract it looks sort of like this: 40% chance of winning, 60% chance of losing. If you win you receive +30% of your account. If you lose, it's -10% of your account.

You could see what the Kelly optimum betsize is, for a coinflip game (which Crude Oil is NOT), and compare that against 10% (for 1 contract), or 20% (for 2 contracts).

You could analyze how many losing trades in a row you might incur, and see whether you feel comfortable losing 10% of your account, that many times in a row.

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