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Money Management
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Money Management

  #1 (permalink)
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Money Management

Hi I like to know know the ideal percentage of capital to risk.
I read somewhere it's something like 1-2%. Is this about right? So this means if I have $100000, if I lose a trade, my risk/loss is $2000, or 2%. If I win, my risk would be a little bit more on the next trade? Thanks

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Good general rule, but if you are day trading and putting on 5+ trades a day then that's a little different than swing trading 20 times a year. The more active you are then the smaller you want to start out until you can prove yourself. If day trading then I would start with a few shares and not worry about commissions.

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Experience, experience, experience...

If you are new, and swing trading, yes 1-2% is about right. If you are new and daytrading, 2% will eat your lunch before the year is over.

In contrast, if you are very experienced and willing to push some extremes of the box, you could risk 10% on an "emergency stop" because you know yourself well enough, but you will get out if you believe you are wrong way before that.

If you want to daytrade, have $100k, and ware new... risk $500 per day, and when it hits, stop for the day. Make your stop $250.00 per trade, your target infinity.

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Gary nailed it. As you gain more experience, you'll adjust your risk depending on the trade.
Most of the time you stick to your mechanical model and every once in a while you'll push it.
2% is pretty standard but 10% is not out of the question.

Psychology > Strategy ≥ Money
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GaryD View Post
Experience, experience, experience...

If you are new, and swing trading, yes 1-2% is about right. If you are new and daytrading, 2% will eat your lunch before the year is over.

In contrast, if you are very experienced and willing to push some extremes of the box, you could risk 10% on an "emergency stop" because you know yourself well enough, but you will get out if you believe you are wrong way before that.

If you want to daytrade, have $100k, and ware new... risk $500 per day, and when it hits, stop for the day. Make your stop $250.00 per trade, your target infinity.


Isn't swing trading and daytrading winning percentage or risk/reward about similar, thus 2% can be applied to both? And what do you mean by target infinity? So you mean at most I can only lose 2 trade at $250 each =$500?
I'm a swing trader, not yet a day trader.

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Hi
1% to 4% of total capital is somehow the range that most traders end up using for their stop losses per trade.
But this doesn't mean that you have to pick up a number randomly, let's say 2% and go with it.
The truth is that it is a combination of many other factors, including winning probability, average loss per trade and also average win per trade.

The overall formula that you wish to maximise goes like this:
Profit = #Trades x Expectancy = #Trades x (win% x avgW - loss% x avgL)

Since the number of attempts, trades, or trials that you take is an important factor in there, the idea behind the 1% to 4% of total capital as a stop loss is to allow you to play several times.
If you risk 10% of capital, you can get yourself around 10 losing trades in a row before you run your account to zero.
However, if you risk only 1% of capital, then you can withstand perhaps 100 losing trades in a row before bankruptcy...

Of course, it is practically impossible to lose on 100 consecutive trades, I've never seen such a case yet, even a broken watch is correct twice a day as they say but it remains a valid statistical case nonetheless and theoretically valid.
At the same time, bankruptcy shouldn't be the limiting factor neither, but a personally set limit of how big of a loss you are willing to take for trying a trading system, or simply what is the minimum cash that you require to continue trading your standard position size.

As an example, let's say you trade 20x ES contracts on a swing basis as your standard position size, and thus you have to hold overnight and provide for the minimum maintenance margin required by the exchange($3,500 per contract).
This would mean that the absolute minimum cash that you have to keep in the account is $70,000.
This is definitely not a good position size for a $100k account (I usually advise to keep margin 15% to 20% of total capital max), but just for the sake of example, in this case you can then allow yourself a max loss of $30k. If you are risking 2% of total account on each trade, you will quickly reach your limit after 15 losing trades in a row. A little bit more to be honest, since your loss per trade would reduce as your capital reduces: remember it is 2% of total available capital, and that goes down as capital goes down. But either way, you get the idea


On the other hand, alongside your stop loss, you should not forget the average gain per trade too. If you risk 2% let's say for the average loss by sticking to your stop, how much will you gain when you get yourself into a successful trade? Would you also gain 2%, 4%, or just 1% of total account?

This is a very important part of money management, not to be neglected, and it should work hand in hand with your stop loss and the resulting average loss per trade parameter.
On an day trading style, you naturally expect to score a high number of trades; and thus to get an equivalent profit you can allow yourself a lower expectancy than say on a long term swing trading style where your number of trades is relatively low. Remember the formula: Profit = #Trades x Expectancy

Finally, to answer your last message, I believe that winning percentage is relatively the same between swing trading and day trading approaches, for the simple fact that most traders use the same technical analysis approach on all time frames, whether it is a 5min chart or weekly chart. But if you don't, then they won't be the same of course; this is dependent on your trading system, different approach, different system.
But risk/reward ratio is one factor that more often than not is radically different between swing and day trading. This is also very dependent on your particular instrument, how it trends, how volatile it is, how it get swayed by news and rumours all over the day, and so on... and of course how strong of a trader your are to manage your feelings.

As a general rule, I've mostly seen swing traders targeting 1:3 to 1:4 risk/reward ratios, while day traders are very often happy with just a 1:1 to 1:2 ratios.
Your broker will definitely be happier with you day trading, and attempting a 1000+ trade per year he would score high on commissions!

Do not confuse winning percentage with risk/reward; the first is if you take 10 trades and you win 6, lose 4 you get a winning percentage of 60%; while the second is if you lose 200$ per trade on average and you gain 600$ per trade on average, then you have a 1:3 ratio.
Let's do the calculation on this example just for fun; you lost 4 trades each at 200$ and you won 6 trades each at 600$ for a total profit of course of $2,800. The other way of calculating this is: Profit = 10 x (60% x 600$ - 40% x 200) = $2,800.

Cheers
Fadi

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Last edited by Fadi; August 14th, 2013 at 04:39 AM.
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I've always been in favor of trading 1% or less per trade.

If you're asking the question you're probably new to trading. I'd suggest if you're day-trading risk 100 dollars per trade or .1%. This way if you take 5 trades in a day you'll only be down 500 dollars (about .5%) which will give you a sufficient feel for the emotion of making or losing money with minimum overall impact to your account at the moment. After you make a few thousand dollars with 100 dollar trades I'd suggest to gradually increase to trading no more than a max of 1% of your account on any given trade. This strategy will maximize the longevity of your career while minimizing the overall impact of the potential loss of an edge. Making money should be the least of your concerns until you can prove consistency. Good luck and remember to have fun without letting the market make you come undone.


Last edited by Itchymoku; August 14th, 2013 at 06:33 AM.
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  #9 (permalink)
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I am not happy with the 1% rule

First - I can subscribe to the math @Fadi has mentioned above.

But:
There are so many other factors in trading that we can not put in one box!

a) The risk percentage
Taking a total capital of 500K (house, car, valuables etc.) and putting up a trading account of
30K as an example - you would "risk" 300 per trade when your risk is 1% per trade...
Now you can lose this 300... so what? But if you win... and your ratio is 1:3 - you get 900.
How much has this micro trade brought to your total balance? Nothing at all - it has not
even paid back for the trading costs and hours you had to put in before the first trade.
Sidenote: If you are going to the casino do you normally take ALL your capital with you?

b) The multiplier
You may trade the ES. There are so many instruments from the derivates up the the future
itself - Depending on broker and instrument you can gain or lose very differently on
every point the index is moving. With a higher multiplier your account may grow faster or
like in most of the cases shrink drastically fast.
So for the beginner it is recommended to take the instrument with a low multiplier and to
push that multiplier up when the trades are consistently positive.

c) Different lot size
If you are used to scale in and to scale out and you are investing from 1 to x lots you are
totally not aware on how much every given trade has resulted - you can not "cross-check" your
trading plan. My approach is to journal 1 lot per investment and to compare end of
the week how my trading plan worked. I may go with more lots - even with different size -
and the final result can be seen in the statement. The most important however is to see
if my trading plan brings consistent results which are easily to be compared in every period
back when only looking at 1 lot.

Conclusion:
- Trade on SIM first until consistency (best with always 1 lot)
- Optimize your trading plan
- Omit weekdays with negative or poor results (check your statistics)
- Optimize your SL settings
- Take higher multiplier and/or higher risk percentage if everything above works fine in real trading

GFIs1

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Having just recently read Van Tharp's Definitive Guide to Position Sizing, i have to recommend it. Very detailed analysis and a real eye opener for me.

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