This is the fifth article written by Mario Cesolini for Unger Academy. Mario is a trader specialized in the conception, programming and development of trading systems, always looking for the perfect algorithm. The search for new strategies never stops. There are times when everything is hectic and times when everything goes in slow motion.


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I would like to return to the third article in this small series.

The most attentive readers will remember that we were looking for something that would allow us to increase the average trade of a strategy based on the SPY ETF. The trading system returned interesting metrics, a good equity line and it seemed like a good working basis. The average trade clearly represented the weak point.

Let’s stop for a second.

What exactly is the SPY ETF? It is an ETF, a financial instrument, which replicates the performance of the SP500 index. Simplifying it, it is a so-called passive-management investment fund: the managers are limited to buying components (shares) of the SP500 index. Therefore, its quotations faithfully, or almost, replicate those of the index.

Is SPY the only financial instrument we have available to trade this market? It is not the only one: we have ETFs, CFDs, futures and options available. Among these, those that seem to do for us are futures.

As many readers already know, one of the futures contracts through which it is possible to trade the SP500 is the ES: the mini futures characterized by a big point value (monetary value per point) of $50 and a tick (minimum movement) of 0.25 points (which corresponds to $12.50).

Now let’s make a small calculation: in post number 3 we stopped at an average trade of 70 dollars investing 10,000 dollars for each operation. As a percentage, our average trade was around 0.7% of invested capital.

At the time of writing, the ES futures with the nearest maturity is quoted at 2860 points, which multiplied by $50 per point returns a counter value of $ 143,000.00. That’s right, by buying a futures contract we move a capital fourteen times larger than our $10,000, which we initially decided to invest in the ETF SPY.

OUR TRADING SYSTEM AND THE ES FUTURES

Let’s see how our trading system would behave by operating on ES futures (1 contract for each trade).

Below is the equity line (close-to-close and detailed) and the main metrics:

Equity Line close to close – ES futures

Equity line Detailed – ES futures

The equity line is good and the average trade is 364.58 dollars.

The problem of having a large average trade seems to have been solved. But now we have to look at the other side of the coin.

I enclose the performance report in Excel format:

Performance Report Excel format

FINANCIAL LEVERAGE AND MAXIMUM DRAW DOWN

In order to have a higher average trade we have used a financial instrument with a much higher leverage than the ETF SPY and, we must not forget, the leverage works the same way for winning and losing transactions: the maximum DrawDown to open positions has increased to over $11,700.

CONCLUSIONS

I continue to consider this trading system as incomplete to go to the market because, as said other times, it lacks risk management.

If our strategy had been complete, what would have been the capital necessary to trade it? We have to analyze two elements, different for each trader: the available capital and the ability to withstand losses.

With regard to the available capital there is little to say: it is a number that cannot under any circumstances be less than the sum of required margins and maximum drawdown.

With regard to the ability to bear losses, every trader is incredibly different from everyone else. The investor who cannot stand 10% of drawdown will be undercapitalized even with a capital of 100,000.

An always valid rule is to think in percentage terms: we can decide not to risk more than 2% in every single operation. If the strategy had (but it does not) a stop loss of $1,500, the capital needed to trade it would have been 75,000.

To the next post.


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