WizzyÕs White Papers …

To Martingale or Not …
… that is the Question

ItÕs certainly a good question!

aka ‘Is Dynamic Position Sizing (based on Win/Lose) a good thing?Õ

 A Simple Re-Entering Backtest
1. LetÕs start with a simple re-entering backtest.

2. This isnÕt intended to be the ‘greatest ever backtestÕ, but it has reasonable CAGR, generally
consistent profitability, and low drawdown. ItÕs not bad. And itÕs only going to be traded
about 25% of the time – so hardly an aggressive backtest.
3. Obviously, some of the trades are winners, and some are losers; about half-and-half (which
as a test sample, is great).

A. Vanilla Backtest Results

4. Results / Comments:
 Total return +43,340
 Max. Drawdown 4.4%
 Consistently profitable (no extended ‘flatÕ periods)
Conclusion; not bad at all
 B. Simple Martingale
5. The approach here is straightforward:
(a) if a trade is a winner, then the next (same day re-entry) trade uses a position size of
1 contract.
(b) if a trade is a loser, then the next (same-day re-entry) trade doubles the position size.

6. Results / Comments:
 Nearly all the time, this approach (in Excel) produces a positive result for the day. Yay!
 The overall return is +80,000 (nearly twice as much). Although thatÕs not quite as
impressive when you consider that the average number of contracts traded is 4.3.
 The max. drawdown is 56%. ThatÕs going to be quite spicy. Particularly if the max.
drawdown occurs early into trading this strategy. The good news is that a large
drawdown wonÕt happen very often.
 Unfortunately, on that fateful drawdown day, the no. of double-down contracts traded
reached 512. That would require a margin of about 5 million dollars. So in practice not
achievable. There are plenty of other days where the no. of contracts traded was in
excess of a dozen. So this is just a ‘mathematicalÕ result – there would have been many
other days which could not have been ‘savedÕ by Mr Martingale
 C. Reverse Martingale
7. Why not try the opposite idea.
(a) if a trade is a winner, then weÕre obviously onto a good thing, and letÕs double the
position size for the next trade!
(b) if a trade is a loser, then letÕs be more cautious, and only trade 1 contract next re-
entry.

8. Results / Comments:
 The overall return is +80,000 (nearly twice as much). Given that the average number
of contracts traded is 2.2, that seems proportionate.
 The max. drawdown is 11%. ThatÕs not terrible
 But performance is very ‘lumpyÕ. There are long periods where not much happens, and
then a few really great days.
 ThereÕs also a sizing issue – the Excel analysis requires up to 64 contracts (on the ‘greatÕ
days. ThatÕs 600,000 dollars of margin. So the great gains are only hypothetical.
 Interestingly, it does seem that if thereÕs a very good day, then the next day is also
‘very goodÕ. Maybe it would be worth doubling down after a ‘very goodÕ day? I wonder if
thereÕs some correlation between ‘first trending dayÕ and the next day. This could be
an interesting backtest?
 Overall, this doesnÕt seem more attractive than the vanilla version, if that was traded
with 2 contracts.
 D. Switch It Up
9. In order to avoid silly numbers of contracts, perhaps just using a simple ‘switchÕ is an idea?
(a) if a trade is a loser, the next trade size is 1 contract.
(b) if a trade is a winner, the next trade size is 2 contracts.

10. Results / Comments:

 This doesnÕt seem like a bad idea
 The overall return is almost +60,000 – well up on the vanilla backtest
 The max. drawdown is 6.3%, which is proportionate
 E. 1.37 Contracts
11. The number of contracts traded in ‘Switch It UpÕ was, on average, 1.37.
12. What would the original backtest look like, if ‘1.37 contractsÕ were traded (obviously this Is
not directly backtestable in OO, but itÕs easy to just multiply the winners and losers in Excel).

13. Results / Comments:

 Funnily enough, this graph looks very similar to the previous one. In fact, the total
profit is (very slightly) higher
 The max. drawdown is 6.0%
 Seems like messing around (a little) with position size brings no benefit
 F. Linear Martingale
14. How about a ‘linearÕ (not exponential) Martingale …
(a) if a trade is a loser, then increase the position size for the next re-entry
(b) if a trade is a winner, then decrease the position size by 1 contract

15. Results / Comments:

 The maximum position size was 11 contracts. ThatÕs achievable (if a little nail-biting).
 The average position size was 2.7 contracts.
 Total return was +105,000. Which is less than the vanilla version would have given if
traded at 2,7 contracts
 Generally, thereÕs quite nice continuous returns
 The max. drawdown is 14.2% - which is a little on the high side
 Seems like messing around (a little) with position size brings no benefit
 G.Linear Martingale (Reverse)
16. I had the Excel spreadsheet to hand but was running out of ideas.
17. How about a ‘linearÕ (not exponential) Martingale …
(c) if a trade is a winner, then increase by 1 contract only the position size for the next
re-entry
(d) if a trade is a loser, then decrease the position size by 1 contract

18. Results / Comments:

 The maximum position size was 9 contracts. ThatÕs achievable (if a little nail-biting).
 The average position size was 1.9 contracts.
 Total return was +75,000. Which is less than the vanilla version would have given if
traded at 1.9 contracts
 As with some other attempts, there are periods of stagnation followed by short bursts
of positivity. Not fun to trade.
 The max. drawdown is 8.3%
 Seems like messing around (a little) with position size brings no benefit
 Grand Conclusion

1. With this sample dataset, thereÕs no benefit to any of the more obvious types of ‘dynamic
position sizingÕ. All varieties of flexible position size make the backtest worse, in one – or
more than one – way.
2. Much better to simply adopt an appropriate position size at the outset, and just trade that.
Obviously ‘position sizeÕ can be ‘no. of contractsÕ or ‘portfolio margin allocationÕ – both are
viable approaches.

YouÕve heard it before, and youÕll hear it again … “consistency is key”