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Start with a sim account. If you can double it, then use real money. Just my 0.02 from years of losing substantial amounts trying to learn the game. Didn't have realistic sim accounts back when I started, so had no option but use real money to learn.
1. Get a good charting and trading programme
2. Get a live data connection
3. invest in a lot more books
If you can't make money on the sim you can't make money live. So .. get your method sorted.
If you know how to code - then build a few indicators and then a strategy and test it.
If you don't know how to code - spend some of that 10K on a few programming books.
When you can put the many decisions that you will need to make when trading (either SIM or live) into code it will help you to really hammer out your plan.
Your biggest weakness at the beginning will be the desire to make money. The voices in this answer are unanimous. Your biggest strength will be the ability to follow the advice. It's up to you to develop that strength before you trade live ! You can't buy it.
@stdras: Whether $10,000 is enough or not enough, depends on your trading strategy.
-> If you head for scalping, you are probably doomed, as you will not make back the commissions.
-> If you follow a countertrend strategy, you will probably need larger stops which increases the risk of ruin.
I therefore assume that you are a careful trader focusing on early pullbacks of a trend. Now let us have a look at the daily range of ES. Over the last 3 months the average daily range of ES during the regular session was 12 points. So let us assume that you have a strategy that allows you to catch a third of that potential twice per day, that is with a profit target of 4 points and a stop loss of 2.5 points. Let us further assume that you have 45% winning and 50% losing trades. Let us further assume that you make your homework and do not trade during news releases, as you may not get filled during such releases at a stop of 2.5 points, if the trade goes against you.
The next question is your risk tolerance. Let us assume that you wish to double your account, and that you will stop to trade, when your account has dropped to half the equity (which is the usual definition for ruin). Following this idea, your target account would be $ 20,000 and your ruin $ 5000.
The next question is your risk tolerance. Let us assume that you are happy with a risk of ruin of 5% (50% drawdown). Now we have everything to do our calculations.
The result is shown below: The Kelly criterion tells you that with every bet you may lose 7.1% of your capital - or $ 710 in your case. However, few professional traders will follow a fully Kelly approach, because it is too risky. With respect to your risk appetite - risk of ruin = 5% - we determine a risk adjusted Optimal F, which comes out at 2.7%.
This means that you would be allowed to risk $ 270 per trade on your initial capital.
Theoretically ou would achieve your goal after 278 trades. That is if you do very well, you would have doubled your account after 139 business days or 6 months. Your disciplined work over 6 months would make you a gross income of $ 1.600 per month (with a considerable risk of a negative income).
Now I have to admit that I have so far omitted all major risks. In reality, there are a few more points to mention which
- there is a considerable operational risk (break down of your PC, the telephone lines, down-time of broker servers, interruption of the exchange)
- there is a considerable market risk (unexpected news, small crashes)
- there is a significant behavioural risk that you do not follow your rules, that you will be distracted, sick of sittingin front of your screen, getting a call from your girl friend while trading etc.
Further you cannot continue to trade 2 contracts, when your equity has dropped. The model does not take into account fractional contracts, so it may take longer than 278 trades to achieve the goal.
In short, you are still undercapitalized with $ 10,000. Not because you will go broke, but because you do not get an appropriate remuneration for your screen time, even in the best of all worlds. Add the real world risks to the theoretical case, and you will understand that the odds that you will succeed with 10,000 are not overwhelming.
If you are already retired and just trade for your own entertainment, than $ 10,000 is enough to start with.
In case you are young and not born rich, you should rather look for a decent job and not play with as little as $ 10,000.
You did an objective analysis based on your mathematics, and then seem to draw a conclusion that is not based on any of that. You mention operational risk, market risk, behavioral risk, which all traders must deal with, and then somehow reach the conclusion that "you are still undercapitalized with $10,000," because... the compensation for time in front of the screen is not large enough?
Can you show an example of $100,000 capital, using the same parameters (including risk tolerance percentage), and demonstrate how doubling that account is more likely?
@josh: There is risk that can be quantified, and there is risk that cannot. The optimal bet size as a percentage of equity depends on the total risk.
Now, if the quantifiable risk tells you that you are allowed to trade 2 contracts of ES, if there was no other risk, then you know that in reality you should only trade less than 2 contracts.
The risk that cannot be quantified is considerable. One that I forgot to mention in the post above is the model risk. The model that I used told me that I will have 50% winning and 50% losing trades. This statement is probably based on a backtest or walk forward test. Now if market conditions slightly deteriorate, such that the trading system will only yield 47% winning and 53 % losing trades, let us look what happens to the modell.
The modell now finds a risk-adjusted Optimal F of 0.6 % and allows me to trade ....... ZERO contracts.
If you add up the non quantifiable risks
non quantifiable risk = model risk + operational risk + additional market risk + behavioural risk
you will find out that they areoften larger than our quantifiable piece of the risk. Heuristics tells us that most of the traders will go bust, in despite of the models that told them otherwise. In fact the case presented above is not tradeable at all. How can I tell that the values observed during my backtest / forward test will still apply when I am going live with real money. A mere 3% shift of winning trades from 50% to 47% would already kill the system.
I would definitely refrain touching ES with a bank account of $ 10,000. Now this is also a function of risk attitude. If you accept a risk of ruin of 25% (not 5%), then you can trade ES with the account of $ 10,000 - provided that you have found a better setup than the one that I have presented above.
The excel file can be found in the thread on the "Risk of Ruin".
If you have an account of $ 100,000 - then you can go ahead. With the same parameters as above (original case), the model will tell me that I am allowed to trade 18 contracts instead of 2. Let us ignore that the model is not robust with respect to the win rate, as this is not the subject of this thread.
Knowing that there are additional risks that cannot be evaluated, I would probably reduce the number of contracts from 18 to a single digit, let us say 8. This is what my model would suggest, if I had a capital of $ 45,000. It would then take 672 trades or 18 months to double my capital. By the way 8 contracts corresponds to a leverage of about 6.2, which is enough for my taste.
This will not reduce the impact of model risk (if my model is false then I will go bust anyhow), but it will significantly reduce operational, unaccounted market and behavioural risk, which will be halfed in absolute terms. By doing this I am targeting the optimal bet size, which is risk dependent. In fact I have assumed that the non accountable drawdown risk is about the same size as the accountable. Certainly heuristic, but better than relying on the quantifiable risk alone.
Thank you for your analysis -- but how does this model reduce behavioral risk, for example? Is this not trader-dependent, and not model-dependent? Might some traders have "better" behavior trading $10K, compared to $100K?
Firstly the model confronts the trader with a few important numbers and if you use it regularly you are reminded of them and reminded of what you are doing when you hit the buy/sell button.
Let's rewind a little.
1. The model is a statistical tool that "predicts" the likelihood of failure in your trading (i.e. Ruin) depending on how good you are and how big you bet according to your account size.
2. The most important numbers in any system are the win/loss ratio or the "expectancy of your system". If you don't know the expectancy and are pressing the button live - then ... this will not help you. Therefore the trader's role is not just finding entries and exits but also that of being treasurer and financial controller.
3. The main principle behind Kelly is that if your account gets smaller (via losses) then you need to reduce position size as you go along. If you do this you will almost certainly (95% in this case) not go bust.
answer 1: The model helps the trader by illustrating that you need to have a really good feeling for how good your system is. Both the new trader and the experienced trader should aim to find that out and keep a handle on it. If you don't know it then find it out. The model is useless unless you have this strong basis.
Answer 2: Knowing the principals behind Kelly and using it to avoid going bust are liberating for the trader. If you know the expectancy of your system and are trading the right size ... then you can concentrate on execution. It gives you statistical backup that your plan is solid and you are not over-trading.
@josh: The model does not reduce behavioural risk. The risk of ruin is reduced by risking a smaller fraction of the equity. In the example above I have reduced the number of contracts from 18 to 8.
This corresponds to a reduction of the assumed loss per trade from 2.71% to 1.22% of my equity. I do account for non-quantifiable risks by reducing the bet size.
Instead of all this sopisticated reasoning, it is also possible to use a rule of thumb.
If you have a fishy system such as the above (adjusted win/loss 1.2, percentage win 50%), then do not risk more than 1% to 2% of your equity per trade.
If you have an excellent system, you may put 5% of your equity on the table without increasing your risk of blowing up.
With $ 10,000 you should only bet $ 100 or $ 200 per trade with the system above. That leaves you trading at best 1 contract for ES.
The ability to dream big & keep your focus day in & day out on what you want is a great skill that is not taught in schools.
However with $10,000 starting capital & No live trading experience your stops will be tight & you will be running scared.
Think of a New born Rabbit in a Den of wolves.
Depending on your discipline you will slowly or quickly get nickel & dimed until your $10,000 starting capital will be reduced to $zero or close to it.
Another way to look at the trading transaction is every time you put on a live trade your account is then open for legal raiding or some call it robbing by other traders and you will feel like you have been robbed & mugged on a regular basis.
Please do your self a big favour ,slap yourself on the face, throw your books in the trash can & wakeup before you throw away your hard earned money .
