Hi folks,
This question also puzzled me for a long time. I would like to share my understanding on this issue. I think some previous posts have already shed some light on this. Hopefully, my answer is more systematic and can make things more clear. Of course, any criticisms and suggestions are welcome.

My short answer is that there is no “absolutely correct” way to handle reinvestment ratio in order to fully maximize your gain without getting a margin call. The SR rule is more a subjective tradeoff choice rather than an objective rule.

First of all, SR rule is derived from a diffusion model. No model can really model financial markets or how a trading strategy exactly progresses in a financial market. SR rule is itself just one way to protect your account.

Secondly, we take a step back. Let’s just assume this diffusion model is a pretty accurate approximation on how a trading strategy will behave through time. Usually, we use max drawdown or maybe CBI index as a criterion to stop a trading strategy when experiencing drawdowns. If you use a higher reinvestment ratio (reinvest all profit generated so far, and thus higher trading lots), it is more likely your strategy will be expired given a usual expiring criterion (20% percent drawdown or 5% CBI index). If you use a lower reinvestment ratio and thus lower trading lots, you essentially give the strategy more chance and time for it to survive through current adverse market condition and work its way back into making profit again. So, the reinvestment ratio is the tradeoff between making more money when the market fits your strategy and the survivability when the market hits you hard given some drawdown related strategy expiring criterion.

Thirdly, if we think about the strategy development process, more things are subjective rather than objective. In strategy development process, whatever your approach is, backtesting is a step you can not omit. But the question is how long the history data you should use to backtest. Let’s say you want to develop a strategy that can not have more than 20% drawdown and you use 5 years of history. Once you have successfully developed such a strategy, you now set the trading size to the point where 20% drawdown is the maximum during the backtest. However, what if you test 1 more year back in history and you get a 30% drawdown, now should you use the previous initial trading size or modify the trading size corresponding to this new backtest result? If you do not get such drawdown in 1 more year, what about 2 more years back, or 5 more years back? Theoretically, your drawdown will increase given a fixed trading size when you backtest longer history, and thus your starting trading size will decrease when you go live. So, my point is that even the initial trading size (or required capital) is in fact subjective. Therefore, the SR rule based on the initial trading size will also be subjective.

Hopefully I am making some sense here. To answer the initial question, should one use SR rule after stopping a strategy and resuming it, or stopping and waiting some period of time then resuming it, it really depends on your knowledge and confidence on the particular strategy. However, if you don’t have enough information or confidence about a strategy, it is probably better to use SR rule to be safe if you know how much profit one strategy has already made. If you don’t know such information, you better test longer history to be on the safe side. After all, based on years of JCL’s experience on such matter, I assume his advice would be very valuable.