The notion of ‘notional’ capital
During the The Qualifying Series it is a challenge to compare different traders’ approach to money management as well as assessing their skill levels when it comes to picking the right trades and optimising profit potential.
The smart algorithms at PsyQuation are adept at picking the skillful trader but we are often asked how we can compare a trader with a 5k account typically using 20:1 leverage with a 100k account using 5:1 leverage. And more to the point, how can we then assess how this trader will react when they are managing $20 million? We do this by focusing on the returns on ‘notional’ capital rather than the returns on actual capital.
In order to attribute a notional capital amount to a trader, we look at what the traders maximum Net Open Position (NOP) was during an evaluation period, what their typical trading size was, and if there are any major fluctuations in either of these. Based on this information, and using the fact that institutional-sized allocations will hardly ever use any leverage, we assess what the notional capital amount is that the trader is trading.
As a very rough guide, using the above two examples, the 5k account would likely be notionalised to around 50k- so all returns would be reported as a percentage of 50k, not 5k- whereas the 100k account would be notionalised to around 250k.