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Square root rule / Money management for portfolio components #484391
10/20/21 17:35
10/20/21 17:35
Joined: Mar 2021
Posts: 4
Palm Beach, United States
F
flip26 Offline OP
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flip26  Offline OP
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Joined: Mar 2021
Posts: 4
Palm Beach, United States
Hello everyone,

I have read the Black Book, and understand the rationale of he square root rule as it applies to reinvesting profits in highly leveraged systems.

My question relates to the Zorro web page (https://manual.zorro-project.com/optimalf.htm):

In a multi-asset system, what is the rationale of taking the square root of the number of components?

Code
// multi-asset system: reinvest the square root of profits separately per component and long / short trades
var AvailableCapital = Capital/sqrt(NumComponents);
Margin = ifelse(ForLongTrade,OptimalFLong,OptimalFShort)*AvailableCapital*sqrt(1+(WinLong-LossLong)/AvailableCapital);


To be clear, if I have a 5 component system, why can't I allocate AvailableCapital as:

Code
var AvailableCapital = Capital / 5;


Thanks!

Last edited by flip26; 10/20/21 17:36.
Re: Square root rule / Money management for portfolio components [Re: flip26] #484393
10/21/21 10:41
10/21/21 10:41
Joined: Jul 2017
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Zheka Offline
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Zheka  Offline
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Trading a portfolio of uncorrelated 'components' allows to be somewhat more aggressive with sizing - hence 'the square root of components' .

Last edited by Zheka; 10/21/21 10:41.
Re: Square root rule / Money management for portfolio components [Re: flip26] #484394
10/21/21 11:57
10/21/21 11:57
Joined: Mar 2021
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Palm Beach, United States
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flip26 Offline OP
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flip26  Offline OP
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Posts: 4
Palm Beach, United States
Ahh, that makes sense. Thank you.


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