Optimal F

Ralph Vince has written several theoretical books on the topic of money management in trading. For those of you that have not had a chance to read his work – it’s written as an academic proof. He shows that there is a mathematical certainty you will go broke if you don’t trade systematically.

Vince outlines a concept he calls Optimal f. Optimal f in short is a money management scheme that assists in determining the correct amount of shares or contracts to buy or sell (or to own or not own at a given time). While Vince’s work is thought provoking, it is also a bit theoretical and not applicable to real world trading. The problem with optimal f is that the calculation is dependent on the largest trading loss, and you can never know when that is until it happens.

In many ways his base ideas (his thoughts on randomness, odds and probability ring true) why money management are important mirror trend following, but how he achieves his version of money management is overly complex. To some traders Optimal f can appear so elaborate that the thought of any type of money management is too cumbersome.

On the other hand, trend following money management is applicable to real world trading. The money management that is part of trend following is not an academic proof. It is straightforward, basic equations (tied together within a complete trading system) that show how much to buy or sell of a given stock or commodity.

Feedback on Optimal f

TurtleTrader received feedback that points to other Optimal f problems:

  • Vince makes no attempt to adjust for choppiness, volatility, or how well or poorly the system is trading in the current environment [trend followers cover these issues].

  • If you wade through [his book], there is not a money management structure in [trend following] terms. He calculates the level of an efficient frontier for capital commitment and leverage from a system’s historical performance and, as you said, the expected worst loss…[but] you never know the worst possible loss [so this is unrealistic].

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