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Kelly F, Optimal F, and Secure F are all money management strategies used by many traders. While the strategies may seem different, Optimal F and Secure F are actually evolutions of Kelly F. To better understand the strategies themselves, it is helpful to know how they got to where they are today.
There are a few popular variations of fixed fractional money management that look for optimum fractions in order to generate the greatest returns possible when trading. These variations are the Kelly formula, Optimal F, and Secure F.
Kelly F was a concept that came from a Bell Labs researcher. This researcher, John Kelly, found that there was an analogy between growth rate of a trading account, and the rate of information transmission through a communications channel, such as a telephone line. This led to the Kelly formula. The formula is used to determine a fixed fraction that will maximize equity growth. A Kelly formula, however, assumes that losses and wins will stay the same. This means that if you are betting the same, risking the same amount, and you are looking to see the same return, it could be a great formula to use. Larry Williams used a variation of this formula when he won his world cup trading challenge. There are problems with the Kelly formula, however, which Optimal F tried to address.
Optimal F is a strategy that was made popular by Ralph Vince. Optimal F, just like Kelly F, assumes that there is an ideal fraction of equity that must be risked to maximize equity growth. Optimal F is, therefore, just an optimal fraction that can be used. The Optimal F fraction is based on a series of trades, and actually looks at the largest loss over a historical period. This number might provide a very nice fraction that can be used if everything is going right, but it does not address drawdowns. Secure F was created to address the problem of drawdowns.
Secure F is a calculation that is similar to Optimal F, but is based on the max drawdown instead of the largest loss. The creators of Secure F found that the Optimal F value typically led to a position that was not appropriate for a trader. Although Optimal F was based on the largest loss, if a drawdown occurred the Optimal F value was often too aggressive. The Secure F value was made to be more conservative. Keep in mind that a Secure F value will never be larger than an Optimal F value. And this makes sense because a largest loss does not account for a drawdown, which is a series of trades. That series of trades or that drawdown could be substantially higher than the largest loss. If you are basing your fraction, or your money management, on the largest loss it could be a little too aggressive for your trading and your account.
The advantages of using these variations and looking …