The Kelly Criterion

There is a lot of incorrect information on the web about applying the Kelly criterion in the stockmarket. It is very different to applying it in a card game where you either win or lose a fixed amount. In that context the Kelly criterion tells you how much to bet on each gamble. But whether you are doing short-term trading or long-term investing that is not the case in the financial markets where there are continuous payoffs. In this paper, Ed Thorp lays out the Kelly criterion for investing in financial markets. It results in a rule of how much leverage to use when investing in a portfolio. That portfolio could be a buy and hold portfolio of stocks, or it could be a high turnover futures trading account. To determine how much of total net worth to allocate to a particular asset class or strategy is a different calculation. I think you should maximize the Sharpe ratio for your total portfolio. Where to set the stop loss in trading is a similar calculation - you want to use stop loss rules that maximize the Sharpe ratio for the strategy. I don't think Kelly tells you how much to risk on each trade in the way it can tell you how much to bet on each gamble.

The Kelly criterion isn't a practical rule in the real world as it requires you to continuously change the size of your position as you win or lose money. The suggested leverage for my trading model – this may be exaggerated because of too short a sample of returns and volatility – is greater than that allowed by the futures exchange. This amount of leverage would immediately blow up in the real world and result in huge amounts of commission and bid-ask spread payments...

Very Good Service from Interactive Brokers

We phoned Interactive Brokers about the login problem. They have a system issue. They set up the account so it can accept a temporary security code which they gave to us. We'll use this until they resolve the issue. The questions they asked to confirm our identity apart from a couple of the typical secret questions were what the net asset value in the account was, what position was in the account (short NASDAQ 100 futures), and what bank we use to transfer money to the account. If we had stolen a password we would have know two of those at least, because you can login into the account on a read-only basis with the password.

I managed to use the temporary security code to set up the mobile app which can produce codes even if it can't receive texts.

Can't Log Into Account

As of Saturday morning I am not receiving the test messages from Interactive Brokers that I need to log into the account. I sent a text to myself using Skype, so it is not the same problem that I had in Japan where I just can't receive texts. If this is still the case on Monday morning we will need to phone the broker to resolve this. They do have a mobile app that can generate the required login numbers even if you don't have phone service, but to set this up you need to get a text from the broker... At the moment this isn't a problem as the model is short for Monday still. In the worst case scenario, I can trade in the opposite direction using my own trading account until the stop is hit at NQ=7441. As my account is much older I have a physical security device - actually a bunch of codes on a card. But I will need to sell stocks/and or transfer money into my account to have enough margin to trade with. And this isn't ideal as profits are taxed higher in my account.

Switching to Short

The model has switched to short as at the open of today's Globex session (8am Eastern Australian Time, 6pm New York Time). I went short 2 contracts in an attempt to move to Stage 3 of the experiment.... The stop is at NQ=7441 and am short from 7383, so risk is relatively low (compared to what it might be), though the nearer the stop the greater the chance of hitting it...

Selling Everything

Well, in my mother's former account. Apparently the main (international) bank doesn't care that we the estate hasn't yet completed probate. Another local bank is, by contrast, very concerned about that. If we sell and go to cash, apparently we avoid paying this investment bank's very high fees. The account has returned practically nothing after fees in the last three years. August and September are historically bad months for equities (though only about 20% of the account is in equities). As we want to sell in the end anyway, it makes sense then to sell now. The plan is to hold everything in US Dollars in the interim.

Stopped Out Again

So, I put on my second trade of the month - long NQ - and was stopped out again, losing $1100 this time. The stop actually saved about $300 this time. But the model is still long for 17 July and so I put on a new long trade at 8:00am Australian time at 7320, which is up $190 at the moment. Stop is 7253 on this trade, currently at 7329.75. Down about $1700 for the month so far. NASDAQ 100 model is up 3.6% and NASDAQ 100 index 4.5% but I'm down 4.5% (due to two bad trades only and leverage). I'm determined to stick to the model now... let's see how I do.