Number of trades Increases and levels off.

•US Bond -DM

750 1000 1250 Initial money management stop ($)

Figure 4.12 Effect of initial money mangement stop on number of profitable trades. As the stop tightens, fewer and fewer profitable trades survive. The upper line is for the deutsche mark and the lower line is for the U.S. bond market.

We can get around this problem by using a volatility-based initial money management stop. For our calculations, we can set an initial money management stop as a multiple of the 15-day SMA of the daily true range for measuring volatility. We use the same continuous contracts as in Ta­ble 4.2 to test the U.S. bond market with volatility-based stops ranging from 0.25 to 3.0 times the 15-day SMA of the daily true range.

Figure 4.13 shows that a stop set at less than 1.25 times the average volatility is too tight. Once the stop increases past 2.00, the paper profit increases and the drawdown increases. The drawdown is minimized at a 1.50 stop. This means there is a balance between being too tight or too loose. The same behavior can be seen very nicely in the live hogs market (see Figure 4.14, page 93).

As might be expected, when we increase the money-management stop, the largest losing trade will probably increase. This happens be­cause our stop is farther and farther away from the entry price. The sugar market shows this nicely (see Figure 4.15) when tested over the

92 Developing New Trading Systems