Pyramiding after a maximum favorable excursion support

What maximum favorable excursion records

Maximum favorable excursion is the peak unrealized profit a trade reaches before the position is closed. Runup is the unrealized open profit accumulated during a trade's life.

An MFE scatter compares each trade's closed profit or loss against the runup it achieved while open.

When size is added

The strategy adds to an open position only after a trade clears a historically identified runup, or profit-support, level. Pyramiding here means adding contracts to an existing position after a selected MFE support level is penetrated.

A profit-support level is a previously identified runup threshold that, once cleared, tends to act as a floor for remaining open profit. Once open profit penetrates a chosen percentage threshold, remaining life of the trade is described as typically staying above that support.

The three-stage procedure

Application is described as a three-stage procedure. First, confirm exploitable runup-versus-realized-profit behavior. Second, choose an add-on support level. Third, retest so risk-reward remains intact.

How add-on levels were ranked

Candidate support levels were ranked primarily with net profit and a composite reward-risk index that folds in time in the market and drawdown. The risk-reward ratio is that composite comparison of profitability against drawdown and time in the market, used to rank candidate add-on levels. The RINA index is the single reward-risk figure combining net profit, time in the market, and drawdown.

A return-retracement ratio above 3.0 was treated as a favorable sign. Return-retracement ratio is an alternative reward-risk ratio to Sharpe that emphasizes return relative to equity retracement.

Illustrated add-on tests added two contracts after a predetermined MFE support was penetrated and then compared net profit against percent equity drawdown. The drawdown limit is the equity-drawdown bound used to accept or reject an MFE add-on setting after retesting.

One illustrated setting raised net profit by 127 percent while percent equity drawdown rose 56 percent. Another raised net profit 92 percent while percent equity drawdown fell 34 percent. Among the illustrated settings, the more palatable risk-reward profile was the one that combined a sizable profit increase with a lower percent equity drawdown. The illustrated tests placed the preferred risk-reward support band between the 2 percent and 3 percent runup levels.