Utility Calculations in Your Trading

Submitted by Marco Palmero on 3 October, 2009 - 11:30

Utility Calculations in Your Trading

I suffered a major trading loss recently and I was pondering about my profit and loss calculations. For example, a trading account can start at $500 and be traded up to something like $2000. So that’s a 300% profit on your initial investment. However, what if you have traded your account all the way up to $4000 (or have started your account at that figure) and found you’ve literally burned that trading account down to zero – in your books that would account for a 100% loss. Personally I see a disconnect between saying I’ve lost 100% in my account (where you’ve lost $4000) and I’ve won 300% (from an account size of $500). I was reading something about utility as explained by B. John Von Neumann and Oskar Morgenstern, in The Theory of Games and Economic Behavior and wondered if I can use this theory to some use in putting some proportional magnitude in my trading profit and losses.

I won’t really use utility in my calculations since that deals with the law of diminishing returns (which I can use for this case, but I don’t want to make the calculations too complicated., but rather the concept of putting an X value to a bunch of cash – a value that I choose to use. So for example if I use the concept of X equals to $500 (which I’ll call Monkey Cash – use whatever you feel like) and continuing with the above case study: in the winning case I put down 1 Monkey Cash to gain another 3 Monkey Cash credits. While in my losing example, I started off with 8 Monkey Cash Credits which I lost. Now to me, that sounds more fun and also puts my wins and losses in perspective.