How do you handle cash drawings out of your modelling?

Discussions about Money Management and Risk Control.
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LeapFrog
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How do you handle cash drawings out of your modelling?

Post by LeapFrog » Sat May 07, 2005 11:30 am

(Perhaps this topic is already discussed and if so I apologize and please point me to it.)

One thing I've never seen explicitly dealt with in system modelling is the outflow of cash over time to basically remunerate the trader - in other words taking money out of one's equity base for things like taxes, food and shelter, boats, cars and trains, etc.

After all, the "real" measure of a trader's success, or a system's success for that matter is how much cash it actually generates or "throws off". In other words, a simple Net Present Value, or Internal Rate of Return of actual cash flows.

Say we start with $500K in risk equity, trade it with 1% risk on each trade in a system that generates a net 100% annual rate of return over 20. This will pile up a ton of cash over those 20 years, in theory, but in practice we will die first of starvation (without another form of cash income elsewhere).

Perhaps Trading Blox or Veritrader has this functionality but nothing else I've ever seen in books or trading platforms ever seems to mention this issue.

I'm curious how to go about modelling this in some systematic form and generating "net-net" cash flow numbers and return on equity measurements from my models. I know the practical reality is that a lot of us will simply grab some cash now and then when needed and reduce our working equity base number accordingly - $10 or 20K here or there. And as for paying taxes each quarter we have little choice about how that happens. I for one draw it out of my trading account the day it is calculated (not the date due) and put it in a separate holding account for future payment to the IRS. But this approach seems less than ideal.

What do others do?

Thank you in advance for any comments or advice.

Leapfrog.

Tim Arnold
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Post by Tim Arnold » Sat May 07, 2005 12:30 pm

Hi LeapFrog,

I've been thinking about this as well, and in Trading Blox I have setup my Money Manager to do just as you suggest.

So rather than using the default system equity, I have my unit size based on available equity minus some $$ per period. So I can simulate a cash withdrawl from the account every day/month/year and trade accordinly.

The results still show gross equity at the end of the simulation since it doesn't know about the withdrawls, but the system trades correctly and if you subtract the withdrawls from the total you get your ending equity.

I'm sure we can make this more seamless in the future (like reducing system equity during a test run), but that's what we do for now.

Tim

bolter
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Post by bolter » Thu May 26, 2005 12:21 pm

Leapfrog,

If memory serves me correctly Ralph Vince published (his 1st book I believe) several variations to the risk of ruin formula that specifically dealt with various capital withdrawal regimes.

If you want the formulas and don't have the book I can post them - let me know.

Cheers

LeapFrog
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Post by LeapFrog » Thu May 26, 2005 12:27 pm

bolter wrote:Leapfrog,

If memory serves me correctly Ralph Vince published (his 1st book I believe) several variations to the risk of ruin formula that specifically dealt with various capital withdrawal regimes.

If you want the formulas and don't have the book I can post them - let me know.

Cheers
Maybe it's time I got a copy of his work for myself - do you recommend any particular one of his works?

Thanks in advance,

Leapfrog.

bolter
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Post by bolter » Thu May 26, 2005 12:52 pm

Leapfrog,

I consider his first 2 books to be veritable bibles. I'm yet to fully comprehend his third book- so I can't recommend it. I can never seem to finish it.

His ideas tend to be controversial, but as a trader, they are too important to be dismissed summarily out of hand.

Good reading.

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