Where is a risk management utility based on correlation? - page 2
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Again, my desire to write a program and understand risk management more can be explained by asking these questions:
1. What is the ideal risk percentage per position? (Most people already teach %1-2%)
2. What is the ideal risk percentage of your entire portfolio (Most prop firms put this at -5% for max drawdown)
3. So if your max portfolio risk is set to 5%, then that allows for 5 positions at 1% risk each, right? And if so, is this the "best" approach?
4. What about, as an alternative to question 3, to set each position risk at .5% instead of 1%, making the number of positions you can have in your portfolio equal to 10. Now we have 2 approaches that meet our standard 5% portfolio risk requirement. Which is better? Maybe approach #4 is better because of the added diversification? Maybe not unless you understand how each currency is moving in relation to each other...
5. Enter my desire to factor in currency correlation. If we could predict how pairs move in relation to each other, we could take on more portfolio risk without hitting our drawdown max. So now instead of having 10 pairs at .5% each, or 5 pairs at 1% each, we could push it and do 5 pairs at 2%, or 10 pairs at 1%. This gets dangerous because if our predictions about correlation are wrong, then we could go above our 5% drawdown tolerance and break rules for our prop firm.
6. Anyway the point is I think that to simply say "2% risk for every position" is too crude. Shall we risk that much for every quarter of the year? Shall we consider the state of the markets, the size of our account, how volatile the markets are at this time of year, how high the volume has been lately, all these different factors should influence how many positions we're supposed to have in our portfolio, and the risk of each of those positions.
Also, I've considered adding a directional multiplier in my code, right now the algorithm doesn't take into account the direction of your trade. It may be a major flaw. I didn't add it in initially because I thought that losses could only move in one direction (negative) and the positive and negative qualities of the correlation coefficients were enough.
I guess I will have to just move into testing.