Guys I'm having problem with understanding the risk management.
The general rule of thumb is that we should risk 1-3% with every trade. Thats fine. But the problem is, how do you guys determine s/l on daily entries, since ATR can go to around 100ticks (futures) depending on the volatility, so that would mean that i need to have 100k account approx. to trade on daily charts?
I am still a noob and still practicing demo account, but when i start, my account will not be bigger than 5k, and i have no means of making it bigger. Thats why i am trying to cope with small time frames, with going up to 5% as the biggest risk.
Big thank you to Mike and the rest of you wonderful people who have contributed to creating this amasing forum.
I think you're making the mistake of setting your risk tolerance before evaluating your strategy performance.
Risk tolerance is mainly determined by strategy performance, namely drawdown.
If you test/sim for 6 months and you observe a drawdown of 20% (account balance), then you must start with enough capital to weather 20% (and some factor of safety....the old saying is that you're largest drawdown is still yet to come).
Having said that, if you're trading a fixed/discrete instrument (like futures contracts) and say you're trading the E-mini and you need $3500 for one contract (not sure what it is these days).....and you've observed through your paper trading and backtesting a drawdown of 20%, that would mean you would need a MINIMUM of $3500+20%) to ensure that if you enter live at the wrong time, you won't get drawndown and knocked out of the minimum margin requirement for that instrument.
If you're trading a more continous/liquid instrument (like stocks) and you observe a drawdown of 20% trading one share, then your money management should feature a strategy that incorporates a position size less than something that would draw you down below your account min.
Obviously, with either, you have to anticipate share float/slippage and commission burden and adjust your position sizes accordingly.
In the end, I'll say that the number one commonality among losing traders (in the research I've seen) is undercapitalization.....or in other words, they were trying for profits greater than their account could handle. In essence, if you observe that the most trades you lose over a given period (and negative equity) is $5000, and you have a $5k account, then you're really pushing the envelope and succeptible to outlier performance periods.
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I do actually have some of these factors incalculated in my trading plan, such as slippage (i've put 1.5 ticks per trade as fixed number for the backtesting of 500vol charts/2min charts), but i prefer having my s/l fixed depending on the current volatility on the chart and general volatility of the instrument. Sure, I micro manage it, but when i say "fixed" i mean the biggest amount of money i am ready to lose per trade. In the context of psychology versus probability, this proved to me to be the best option so far (i am of course flexible if i learn better) in backtesting and demo live trading-presently i am more focused on practicing PA. Theres also the thing with margin i get with Mirus futures (i'm still demoing though)-prices of contract are from 500-1000 dollars for intraday trading.
I will also put in the calculations for max. drawdown as you recommend. 20% is really big drawdown, that would mean I would need to lose 7-10x in a row. that hasn't happened to me yet though, nevertheless, i am sure live trading changes everything
1. Begin Small - With brokers who offer a small $ / pip
2. Try your strategy - including testing chart parameters - It does not matter how you trade - indicator based, price action based, fundamental based
3. Test your emotions - to your Losses & profits.
Then - You will arrive at a "Risk Parameter" that suits you.
Risk , remember is based on "your" Emotionaltolerance.
Risk , remember is based on "your" Strategy Tolerance
Hope this helps you.
The following 2 users say Thank You to sunny2010 for this post:
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