The Leverage Space Trading Model: Reconciling Portfolio Management Strategies and Economic Theory

206 Pages·2009·2.35 MB·English

by  Ralph Vince

(continued from front flap) $65.00 USA/ $78.00 CAN
Praise for VINCE
complex desires, what’s the alternative? As Vince THE LEVERAGE SPACE TRADING MODEL

shows, the answer is to utilize the Leverage Space T
H THE
Model as a “framework” to achieve the specifi c
ends a trader or portfolio manager seeks. E
“A s Warren Buffett said, ‘It’s only when the tide goes out that you learn who’s been swim- The cornerstone of money management and
L
The author’s new allocation paradigm avoids ming naked.’ We now know that most have been. It’s too bad that Ralph Vince did not fi nish E portfolio optimization techniques has re-
the troubles that come with mean variance his book in 2005 or 2006, it would have helped save institutional investors and our nation V LEVERAGE mained the same throughout history: maxi-
E mize gains and minimize risk. Yet, asserts Ralph
models—which most models are—and quantifi es trillions of dollars; few people understand the rewards of leverage and its inherent risks
R Vince, the widely accepted approaches of com-
drawdowns to achieve a growth-optimal portfolio
like Ralph. As we found out, most hedge funds and banks use leverage without knowing A bining assets into a portfolio and determining
within a given drawdown constraint, in a manner
how to quantify its risks or rewards. This book is a must-read for anyone using or being G their relative quantities are wrong—and will cost
that satisfi es these seemingly pathological SPACE
E you. They illuminate nothing, he says, aside from
human desires. And for those who don’t wish responsible for risk. Leverage is one of our greatest empowerments.”
providing the illusion of safety through diversi-
to get involved with the mathematics, Vince has S
presented the text in a manner of two congruent, — Salomon Konig, member of the board of directors, Hedge Fund Association, P fi cation. Although numerous Nobel Prizes have
simultaneous channels, with math and without. Partner and Chief Investment Offi cer, Artemis Capital Partners, LLC A been awarded based on some of those widely
TRADING
C accepted principles, their popular acceptance
E does not constitute real-world validation. What
Most simply put, this book will change how you
“R alph Vince is almost alone in his study of trade sizing, but that doesn’t mean he isn’t right.
think about money management and portfolio T has been needed is a viable alternative to directly
Traders should read this book.” R address these real-world dictates.
allocations.
A MODEL
— Euan Sinclair, option trader and author of Volatility Trading
D In The Leverage Space Trading Model, Vince offers
RALPH VINCE is a computer programmer who
got his start in the trading business as a margin I a groundbreaking contribution to the literature that
N
clerk and later worked as a consultant program- “A s we’ve seen recently, the gross misuse of leverage has been a hard lesson for institutions. builds on a lifetime of expert analysis to deliver
G
not only a superior new portfolio model, but takes
mer to large futures traders and fund manag- But position sizing is critical to the success of all traders, big and small, and Ralph Vince
Reconciling the entire discipline of portfolio management to a
ers. He currently consults with businesses and M
brings fresh thinking to an area that badly needs it. He challenges the status quo and makes
new level.
trading operations around the world and speaks
O
you think about what you’re doing. He attacks the major fl aws of MPT. There is no doubt Portfolio Management
frequently in front of professional and academic
groups globally. Vince has been critically ac- that you’ll benefi t from Ralph’s ideas.” D In this book, Vince—who has made many
E Strategies and important intellectual contributions to the fi eld
claimed for his groundbreaking work in money
— Perry Kaufman, author of New Trading Systems and Methods, Fourth Edition and L for over two decades—departs radically from
management, particularly in the development of Reconciling
Optimal f. He is the author of numerous Wiley A Short Course in Technical Trading SR Economic Theory informed orthodoxy to present an entirely new
titles, including The Handbook of Portfolio Math- Portfolio Management trateco approach to portfolio management. At its core,
ematics, Portfolio Management Formulas, The egnc The Leverage Space Trading Model basically tells
Mathematics of Money Management, and The “ If Ralph Vince writes it, I read it . . . every word, every thought this guy has produced has iesilin how resources should be combined to maximize
New Money Management. led me to additional market prSofi ttsr. Maotneeyg miaenasge maennt ids cl early the way to the kingdom ang P safety and profi tability given the dictates of
d
of wealth in the investment world and Ralph gives you the keys in this book.” Eor the real world. But, as the author points out,
Economic Theory cotfo RALPH VINCE given the complex and seemingly pathological
Jacket Design: Loretta Leiva — Larry Williams, trader, fund manager, and author of Trade Stocks & Commodities with nolio character of human desires, we are presented
m M
the Insiders: Secrets of the COT Report and Long-Term Secrets to Short-Term Trading ica with a fascinating puzzle. Research has found
Tna that human beings do not primarily want to
hg
eoem maximize gains—our psychological makeup is
r
ye such that we instead tend to possess seemingly
n
t
more complex desires. If the models don’t work,
if we are ultimately unable to satisfy our more
(continued on back flap)
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The Leverage
Space Trading
Model
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Founded in 1807, John Wiley & Sons is the oldest independent publish-
ingcompanyintheUnitedStates.WithofficesinNorthAmerica,Europe,
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The Leverage
Space Trading
Model
Reconciling Portfolio Management
Strategies and Economic Theory
RALPH VINCE
JohnWiley&Sons,Inc.
iii
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Copyright(cid:1)C 2009byRalphVince.Allrightsreserved.
PublishedbyJohnWiley&Sons,Inc.,Hoboken,NewJersey.
PublishedsimultaneouslyinCanada.
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LibraryofCongressCataloging-in-PublicationData:
Vince,Ralph,1958–
Theleveragespacetradingmodel:reconcilingportfoliomanagement
strategiesandeconomictheory/RalphVince.
p. cm.–(Wileytradingseries)
Includesbibliographicalreferencesandindex.
ISBN978-0-470-45595-1(cloth)
1.Portfoliomanagement. 2.Investmentanalysis. 3.Investments. I.Title.
HG4529.5.V5582209
332.601–dc22 2009000839
PrintedintheUnitedStatesofAmerica.
10 9 8 7 6 5 4 3 2 1
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He that will not apply new remedies must expect new evils;
fortimeisthegreatestinnovator.
—FrancisBacon
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Contents
Preface ix
Introduction 1
PART I The Single Component Case: Optimal f 7
CHAPTER 1 The General History of Geometric
Mean Maximization 9
CHAPTER 2 The Ineluctable Coordinates 21
CHAPTER 3 The Nature of the Curve 29
PART II The Multiple Component Case: The
Leverage Space Portfolio Model 59
CHAPTER 4 Multiple, Simultaneous f—‘‘Leverage
Space’’ 61
CHAPTER 5 Risk Metrics in Leverage Space and
Drawdown 89
PART III The Leverage Space Praxis 139
CHAPTER 6 A Framework to Satisfy Both
Economic Theory and Portfolio
Managers 141
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viii CONTENTS
CHAPTER 7 Maximizing the Probability of Profit 157
Bibliography 183
Index 187