Well in the game of trading, the market usually rewards you for the risk you are willing to take, as long as you are not exploiting an arbitrage position. I am ready to sit on a 60 to 80% drawdown it must come to it as long as the trades in the live session fall within statistical expectation. I believe the capital required is calculated as the maximum drawdown plus the maximum margin required in the test period.
Makes perfect sense to me to be honest. Its how much capital you will need to to hopefully weather the storm, but if its a hurricane then you can possible lose everything. That is why its usually a good idea to go in with atleast 1.5 times the capital required for a risk loving person like myself and maybe a 5 times capital required for a risk averse person like yourself.
But remember your returns are based on the risk you are willing to take.
OK, you have put it all nicely and I can agree with most of what you wrote. You are also right about capital required calculation.
But, while reading your post, it also crossed my mind that not only we might have quite different risk tolerance, but also that we're maybe missing an important variable here. A variable that will shed new light on the whole issue. And that is how much of our savings / net worth are we actually commiting to trade forex? Allow me to explain with an example...
Let's say that both of us have $20000 of life savings and that both of us are attempting to get better return on that money, instead of leaving it in the bank and earning steady 2% per year. Somehow we both came to the conclusion that a) forex market is interesting because of it's liquidity and b) that system trading is the way. So far so good.
Now let's see where we might diverge slightly in approach and thus create an illusion that we have different risk tolerance, when there might be none.
You might say, this forex market is dangerous, I'm afraid of it, so I'll commit only $4000 of my life savings to trade forex. You leave the rest in the bank. On the other hand, because you now stand to lose max 20% of everything, in the worst case, you can actually be very courageous and thus you're willing to see even 60-80% drawdowns, because, hey, you can never lose more than 20%. Right?
Me, on the other hand, I might look conservative, but actually my approach is a bit different, which leads to a wrong conclusion. From the begining, and currently just playing with demo account, I'm pretending that I'm already trading with all of my life savings. So I play from the beginning like I have invested all of $20000 I have.
Now, to match our risk tolerance, we would need to include all those parameters in the calculation. At the time that your $4000 account is say 60% underwater, that is -$2400, mine should be 12% underwater (also -$2400) if we're at the same risk level. If I'm at -15%, that actually means that you're more conservative than me. Even if the numbers tell quite the different story.
So is Sundance risking $5k of $10k of his life savings, and is thus wildly adventurous, or using $5k of $500k, which his grandma left him when she died (and is thus chicken), we really don't know. No hard feelings Sundance!
These money management calculations can really be a bitch and deserves it's own topic (or another one). I'll soon open one, because I have one more thing I'd like to point out.
