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I have developed a fully automated crypto trading strategy for which has been showing promising results and I am now looking to raise money to expand and hopefully trade to its full capacity in the future. My analysis on the backtest results shows there is a small possibility of of 40-50% drawdown (probably once a year or so) if use the biggest position size my backtest allows but if I reduce my position sizes to half, then these DDs will drop to half as well. Now, the question I have is, lets say I have 100k, is there a best practice to scale up (and down) to the maximum amount of money we are going to invest considering the reality that all strategies eventually lose their alpha. Lets say we do hit a big drawdown, at what point we decide to pull the plug. I know we can aggressively reduce the position sizes as we lose but still I think there will be a big drawdown and we will have to decide whether to pull the plug or not. So in nutshell, how does a trader scale in and out of a strategy during the 'whole lifecycle' of a strategy which has worked fine for a while and eventually lost it edge ?

Thanks

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Drawing 40-50% once per year will make it very tough to raise any money. That's way too often for most investors unless your strategy makes more than 100% per annum. Even then, it will be too much volatility for most to handle.

If you desire to scale your strategy into or out of positions, you should adjust your algorithms accordingly, redo all your backtesting, redo all your forward tests, and transition to a live trading account once again. What you propose is a fundamental change to your strategy that you haven't tested.

Alternatively, as you suggest in your post, you could start by exposing your strategy to an amount of capital that results in a smaller drawdown for the account. Potential investors will want to see account-level returns, not necessarily strategy data (though some will ask), so keep the size appropriate.

For example, if I know potential investors won't tolerate more than a 10% drawdown and my strategy draws 50% annually, I will only expose 20% of my capital to that strategy. That will keep plenty of cash on hand to weather a drawdown and not reduce size.

FWIW, I think reducing size during a draw is never what you want to be doing, so I would throw the idea out.

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  • $\begingroup$ Thanks but my question is not around how to scale in and out of individual positions but strategy itself. Lets say I have been testing the strategy with 2.5k for and I have 100k available to invest(assuming the strat has enough capacity), Even though I have done some live trading for a couple of months and its successful, surely it can't be right to start trading $100k account straight away? Secondly, when this strategy actually starts losing its edge, where do we stop, surely we won't stop until we have lost all of our money? $\endgroup$ Sep 22, 2022 at 18:06

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