Most traders view the idea of profit protection as a concept that applies to an individual trade. Whenever a trade floats a large profit, they protect the unrealized profit by moving the stop loss closer to the market.

I like to view trading more as a collection of outcomes rather than the result of any particular transaction. This article looks out how to protect **realized** profits after they accrue in the account rather than protecting the **unrealized** profit from one trade.

The money management project started off by asking the question, “is it possible to make money with a perfectly random strategy solely using money management.” The strategy is not quite to the point where it will work in the real world. Nonetheless, this new method shows substantial progress toward that goal.

I operate on the assumption that a random strategy is one with 50% profitability and an R multiple of 1.0; we earn a dollar for every dollar we risk. The net outcome over hundreds of trials should average out to the starting balance. My earlier videos and blog on money management modeling verifies that this is indeed the case.

Random outcomes tend to fluctuate above and below the average value. At any given time, half of all possible outcomes should be above average. The opposite holds true for outcomes below the average. The idea here is to get away from standard notions of money management like fixed fractional money management. The risk amount should follow not only the account balance, but also factor in the degree of profit accrued.

The fluctuations above the starting balance are totally random. If a trader is lucky enough to obtain a profitable, realized balance, then it makes sense to decrease the risk. Obviously, decreasing the risk limits the potential profits.

Consider an example. We start with a $100,000 account balance risking 1% of the original balance. Note that all future trades base the risk on the original balance and *not* the accrued profit and loss.

When a random winner rolls in, it brings the account balance to $101,000. The odds of winning on the next flip are still 50-50. Rather than risking giving it all back, I found that you increase your chances of a final, meaningful profit if you decrease the original risk as profits accrue.

Reducing the original risk by 1% for every $1,000 of profit changes the dollar risk from $1,000 to $990. This may not seem like very much. That’s because it is not. The goal is to suck tiny little advantages as they come. A loss occurs half of the time in this situation. When it does, the account balance still shows a $10 realized profit.

If the second trade (we are now at $101,000) is a winner, the account balance increases to $101,990. A loser following the win drops it down to $100,010. The process is slow, but we’re also making money without a trading strategy. We’re just betting.

Importantly, a change to the risk amount as a balance loses money completely destroys the money management strategy. It is critical that the risk amount not vary in any way whatsoever.

Baz says

Hi Shaun, absolutely fascinating. Its been a dream of mine to beat the market by money management alone. Years ago i saw a roullette system,i cant recall exact details but say he played red, as he won he would take off a chip if he lost he added a chip. Does that compare slightly in any way in basic terms with your model?

Nice job, cheers Baz

Shaun Overton says

It’s the exact same thing *except* that it’s better to leave the losers alone. The stack should neither add nor subtract to the bet on 50-50 odds.

Davy says

Hi Shaun,

In your article you’ve writting that: ‘If the next trade is a winner,

the account balance now shows a balance of $101,010. A loser following

the win drops it down to $100,020.’

But if I’ve understood you correctly this should rather be $100,019.9

because you lower the risk by 1% after each winning trade. Or am I

missing something?

Could you also clarify your risk strategy after a losing trade?

Many thanks!

Shaun Overton says

Hi Davy,

Thanks for the comment. I realized that the number shown for a winner was incorrect. It should have read $101,

990 instead of $101,010. I fixed this in the article to avoid confusion.Your question relates to the amount lost. The important thing to remember about the risk is that we are taking a percentage of the

originalbalance and not the current balance. The original balance is $100,000. If we’re risking 1%, then our default risk in dollars is $1,000.If we win on the first trade, the account balance is $101,000. However, the risk in dollars will now change. Assuming that I set my decrease amount to -0.01 for every percent increase in the account balance, I now risk 1%-0.01 = 0.99% of the original account balance. That changes the risk and payout changes from $1,000 to $990 (0.0099 * $100,000).

The loss from $101,000 results in a balance of $100,0

10 ($101,000-$990).Could you also clarify your risk strategy after a losing trade?

Keep betting $1,000 until you get lucky and cross above the starting balance. The risk size neither increases nor decreases for losing trades.

Davy says

Thanks Shaun. Your clarification about the losing trades is very important. I’ve been doing some calculations and from a mathematical point of view the expected return is always $0. This is because you are facing a 0.00000000000000000000000000008% risk (50% x 50% x… and this 100 times in total) that you never win a trade. Your betting strategy is related with the martingale strategy, popular in 18th century France. Martingale has been applied to roulette as well, as the probability of hitting either red or black is close to 50%. The gambler with infinite wealth had to double his bet after every loss so that the first win would recover all previous losses plus win a profit equal to the original stake. However, non of us have infinite wealth. More info: http://en.wikipedia.org/wiki/Martingale_(betting_system)

Daniel says

I’m not sure if the purpose of your article was just to illustrate the idea of winning by money management alone or if the theory expressed could actually be applied to a real scenario.

Assuming the latter, when would you stop decreasing the risk?

Thanks.

Shaun Overton says

Hi Daniel,

The goal was to find something workable in the real world. If you’re stuck with random, 50-50 odds, like I am in the video, then it’s a theoretical exercise. Trading costs would eat up the potential profits and more.

Strategies with true profit expectations might consider applying the money management ideas in their EAs.