Pawn Structure, Trading Systems and Money Management     

(Henry Carstens)                                                    

With the Grand Master away at a tournament, I've been left to my own
devices in chess education this week and have begun reading a book on pawn
structure. Naturally, that got me thinking about trading systems, the
problem of allocating risk capital within a team of trading systems and the
similarities between pawns and trading systems.

In every game of chess, pawns are lost and exchanged and the loss of an
individual pawn is seldom catastrophic. Conversely, the loss of the king or
of the other officers is much more serious and perhaps even devastating. The
key idea when relating pawns to trading systems is this: trading systems,
like chess pieces, have different ranks and different responsibilities. As
such, they all carry different burdens of risk and different orders in the
deployment of that risk.

The duty of a pawn trading system is simply to support the officer systems
and to never cause a catastrophic loss to the trading army. Therefore, pawn
trading systems trade with lower risk capital than officer trading systems.
Pawn trading systems attempt to maximize profits only within the parameter
of minimizing drawdowns that might affect the army. Restated, pawn systems
should never cause a real or psychological loss or series of losses so great
that they affect the army's allocation of capital to the officer trading
systems whose ability to generate results has already been proven.

Continuing the analogy, think of the pawn that makes it all the way down the
board and is promoted to knight, bishop, rook or queen. When thinking of
trading systems, this pawn is the system that has survived back-testing,
real-time trading and ever-changing cycles - a Herculean series of
adventures. Through the experience of these adventures, the trading system
pawn earns the responsibility and the burden of carrying additional risk.
Once promoted, it can begin thinking of maximizing its profits on a larger
scale for the trading army.

All trading systems begin their lives as pawns. The first job of the newly
created/purchased pawn trading system is simply to provide what profit
support it can and not impede the officer trading systems with undo losses
that could affect the larger expectations of the army. Given these
responsibilities, a suitable level of risk can be chosen for the trading
pawn and it can be sent out into the battlefield with positive expectations
for both the army and for its eventual promotion to the officer corps.