- Money Management
- How to apply
- Calculate Stop Loss
Money – Management
- Money management is the art of limiting the risk of a portfolio while maximizing its return
- Studies have shown that up to 90% of the variance in a trader’s performance can be directly attributed to it
- Money management is an essential element of success
- It is not complicated, but it requires a lot of discipline
- If you don’t use money management, you could have the best trading system in the world, and still lose money.
- With good money management practices, you could have a 50% accurate system and still earn great returns.
Elements of Money Management
- A stop loss order placed for each Trade
- A specific amount of money to risk in each trade
- The maximum amount to risk over a given period
One trade should not matter
- So what amount of risk should you be willing to take?
- Never risk more than 1% to 3% of your total equity in any one trade
- Keeping your risk small and constant is absolutely critical
- Taking more aggressive risks could easily see your account go up as high as 20% in a day but…
- “One trade should not matter”
Risk Tolerance
Risk Reward Trade Off
- THE CONSERVATIVE TRADER
Values long term capital preservation more than the growth of returns – Accepts low risk for slow and steady growth of returns
- THE MODERATE TRADER
Values medium term returns equally to capital protection –Accepts moderate risk for moderate growth of returns
- THE AGGRESSIVE TRADER
Values short term returns more than capital protection – Accepts high risk for short term extraordinary returns
Risk Profile
Position Sizing
- Position sizing is an essential part of Money Management
- Position sizing is the amount of equity invested on a trade
- Finding the right balance is key to Money Management
- Calculating correct position size (amount to trade)
- Stop loss level in pips
- Amount of money to risk
Calculating – Amount to Trade – Stocks
- Lets’ say you have a possible double bottom and want to go long the share of Apple risking 1,000$
- 100 shares requiring $15,000 as capital
- Lets’ say you have a possible double top and want to short the stock of google risking 2,000$
- 40 shares
Calculating – Amount to Trade – Forex
- Lets’ say you have a possible double bottom on EURUSD and you want to go long risking 1,000$
- 100.000 = 1 standard lot
- Lets’ say you have a possible double top on GBPUSD and you want to short risking 500$
- 200,000 = 2 standard lots
- Risk/Reward Ratios
- Trading Expectancy
- Break Even Points
Risk Reward Ratio - What it is
- The risk to reward ratio shows how much money you are risking versus the potential reward on a trade
- In order to attain the risk/reward of a trade, both the risk and profit potential of a trade must be defined
- Risk is determined using a stop loss order
- Reward is determined using a take profit order
- A stop loss order is designed to limit an investor’s loss on a position
- A profit target is used to establish an exit point should the trade move favorably
Risk Reward Ratio – Calculation
- Lets say you have a possible double bottom and want to buy the Euro
- You are risking 100 pips to make 150 pips
- That’s a risk to reward ratio of 1 to 1.5
Risk to Reward - Examples
Expectancy - What it is
- “Expectancy” is the average amount you can expect to win or lose per dollar at risk
- Expectancy = (Pr. of Win * Av. Win) – (Pr. of Loss * Av. Loss)
- We can also see how you could have a system that is accurate the majority of the time, but have a negative expectancy
- Expectancy = (Pr. of Win * Av. Win) – (Pr. of Loss * Av. Loss)
Expectancy - Break even point
Expectancy - Human Nature
- Most of us would feel better with a system that produced more winning trades than losing
- The vast majority of people would have a lot of trouble with a low accuracy system
- Because of our natural tendency to want to be right all of the time
- The percentage of winning trades is not the most important factor in building a trading system
