Systematic Trading: a unique new method for designing trading and investing systems [PDF]

Summary
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Systematic Trading: a unique new method for designing trading and investing systems – Book

With predetermined trading capital of $250,000 you need to determine how much of that you are willing to put at risk; your percentage volatility target. As I said in chapter nine, ‘Volatility targeting’, this is a matter of determining your achievable performance, inferring from that a safe level of risk to take, and checking you are comfortable with the likely levels of losses.

You’ll be running a reasonably diversified system, with two trading rules drawn from different styles, and six instruments from different asset classes. When I back-tested this system using out-of-sample bootstrapping to ensure a conservative result, I got a Sharpe ratio (SR) after costs of 0.53. Using table 14 (page 90) suggests that about 75% of this is achievable, for an SR of 0.40.

There is a mixture of positive and negative skew trading rules and 90% of the portfolio is in relatively benign assets, with only 10% in the potentially negative skew V2TX volatility future. I’m happy to assume this is a slightly positive zero skew system, which the backtest confirms. From the achievable Sharpe ratio 0.4 rows, column A, of table 25 (page 147), you would get a 20% volatility target and hence an annualized cash volatility target of $250,000 × 0.20 = $50,000.

This is slightly lower than the level I run my own system at; I assume you’re also comfortable with the potential pain of a 20% target, and with leveraged futures achieving the risk won’t be an issue. With this relatively high volatility target you’ll be checking your account value, and adjusting your risk, every day.