We’re pleased to announce that Thomas Krawinkel won the National Association of Active Investment Managers’ 2011 Wagner Award for his paper “Buying Power - The Overlooked Success Factor.” Launched in 2009, the NAAIM Wagner Award is designed to expand awareness of active investment management techniques and the results of active strategies through the solicitation and publication of research on active management. $10,000 is presented annually for the best paper submitted to the competition.
The paper, available on NAAIM’s website, on the Social Science Research Network, and here, explores how a lack of buying power and consequently missing trades introduces an element of random variance that may lead to significant deviations from the system’s true performance thereby reducing its reliability up to the point of uselessness. The supporting EXCEL tools can also be downloaded here.
Practical experiences triggered this study when significant deviations in the performance of trading systems from their “theoretical expectation” were noticed whenever a backtest was carried out in conjunction with money management algorithms. Upon further examination it became clear that skipping of trades (at times when all available funds were already deployed) caused this effect to happen. The consequences are not only simply missing out on a potentially profitable opportunity, but also the introduction of a random element. Not a predetermined rule, but the momentary lack of buying power prevents a valid entry signal from being turned into a position. When “too many” trades are skipped then the impact of chance may significantly offset the inherent edge of the underlying trading system thereby rendering it virtually useless. This effect is both explained in theory and by practical example.
An EXCEL tool is provided that can be used by the reader to examine systems that he is interested in. After entering some key figures on each individual (live or simulated) trade for all signals that this system generates over a certain period of time, the performance differences with and without a buying power restriction can be studied. This should provide valuable insights regarding position sizing, drawdowns and attainable profits as well as the sensitivity in respect of skipping trades.
Finally a “Quick Check” is presented that analyzes the attainability of individual profit goals by the application of a specific trading system. Here the conclusions from the previous chapters are combined with factors that are unique for each trader like the given financial framework (funds, leverage), individual goals (profit target), personal risk preferences (buffer against margin calls, fraction of capital risked per position) and a few basic system parameters.
Mr. Krawinkel presented his paper at the 2011 NAAIM Uncommon Knowledge Conference. The pdf of that presentation is available for download.
Explore how your own systems may be affected by the lack of buying power and download the EXCEL tool described in Mr. Krawinkel's paper. Below is an online version of one of the three tools included in the downloadable EXCEL file.