An invited tutorial by Ralph Vince
Leverage space is simply a manifold, structured such that we can examine and discuss matters pertaining to growth functions of stochastic outcomes, such as processes of money management and portfolio allocations in the capital markets and gambling scenarios. It is a framework for observing and analyzing these functions, as well as drawing conclusions about how we manage these functions for our benefit.
Since growth functions are a function of time, much pertaining to what occurs in the manifold of leverage space is a function of time also. Additionally, we examine what occurs therein in the asymptotic or long-run sense as well.
In our blog “Money Management: the best kept secret of professional investors,” we have emphasized the importance of Kelly’s formula in money management. In the meantime, we have also pointed out that the capital allocation suggested by Kelly’s formula is too risky.
So what should we do in practice? Here we shed some lights on this issue by giving a graphic illustration of the recent analysis of Vince and Zhu .
Watching CNBC you will constantly be bombarded with interviews of traders and investors. List of stock picks and expert opinions dominate the theme.
Putting the correctness of such expert’s opinion aside, the sheer single minded focus on stock picking is already very misleading. In fact, most successful professional traders and investors will tell you money management is an important component of their trading systems.
DJIA (1960-1981) and Conditional Bull Probability
Trend following is an investment strategy based on technical analysis. The basic premise is that the market can be regarded either as a bull market or a bear market at a given time.
Trend followers take advantage of these trends and make their buying and selling decisions. Rather than focusing on predicting specific price levels as in other areas of technical analysis, trend followers simply jump on the trend and ride through it.
There are a several different ways and various time frames to determine the general market directions. Traditionally, moving averages and channel breakouts are used to determine current market trends. Here we focus on a brand new trend following approach developed by Dai, Zhang, and Zhu .