You should identify how you would minimize losses and maximize profits.
•What is the maximum position for a single trade, in terms of capital that you will trade? You will not want to expose too much of your capital on a single trade. So for example if your capital was $10,000, how much of this will you want tied down to one trade? For Forex trading, I will commit on average 5% of my equity for one trade. This will determine also your trade size. What percentage you use, depends on your risk profile.
•What is the maximum amount you are willing to lose for a single trade? Many authors tend to quote anything between 0.5% to 2% of your equity. Some books quote more. You must carefully think about this and work on a realistic figure which should be set based on your risk profile. If you haven’t read “Trading for a Living” by Alexander Elder, you really must because this now legendary book amongst traders deals with this topic in a lot of detail.
•When will I take my profits? Generally try to take incremental profits when you can. This is how professional traders run their business. Forex markets trend very well and what can often be seen is that traders snatch their profits when the big trend is just about to start and they miss on the big move. Don’t forget the golden rule: “The trend is your friend”. Let’s get a bit more specific here. Many traders ask the following questions regarding money management:
1. How to determine the optimum money management for a given sized account?
2. How to choose the best money management strategy based on the nature of the entry/exit methodology and back test results?
3. How can I design my own money management system that works for me and my style of trading?
Let’s try to address some of these questions.
You only have to be trading for a short period of time to realize that money management is more important than the method or system. If you tell new traders this, they just look at you blankly. All they want is a system and signals that they can trade the next day.
Money management is really that important. Now, determining what percentage of capital you should risk is actually a function of your hit rate. For example, if you win 80% of your trades consistently, then you could risk more than if you win 50% of your trades consistently. You also need to know the maximum amount you can trade. In order to do that, you need to know your maximum drawdown recovery rate.
Good money management can be summarized in 4 basic principles:
1. Always risk the smallest amount you can, working on the worst case scenario all the time. How much money would I need to stay in the game if I had X number of losses risking the amount I am just about to trade, with X being the maximum number of losses you have ever had trading the system.
2. Protect your capital. You must calculate your potential loss based on where you will place your stop loss.
3. Most traders stop trading because they run out of capital before they learn enough to make money. The main priority should be to live to fight another day and not lose money.
4. Using a stop loss is one of the things you can control. There is no right or wrong place to where you should place a stop loss. It all depends on your trading plan. If you used certain indicators to enter a trade, you will outline that in your trading plan. Similarly, you will outline where you will put your stop loss based on the guidelines you have set out in the trading plan. For example, you might say: “I am going to enter a trade every time indicator X did this”. “As soon as I place my trade, I am going to place my stop at Y”. To determine Y you must have come up with a plan and back tested how many times you made money without Y being hit.
•What is the maximum position for a single trade, in terms of capital that you will trade? You will not want to expose too much of your capital on a single trade. So for example if your capital was $10,000, how much of this will you want tied down to one trade? For Forex trading, I will commit on average 5% of my equity for one trade. This will determine also your trade size. What percentage you use, depends on your risk profile.
•What is the maximum amount you are willing to lose for a single trade? Many authors tend to quote anything between 0.5% to 2% of your equity. Some books quote more. You must carefully think about this and work on a realistic figure which should be set based on your risk profile. If you haven’t read “Trading for a Living” by Alexander Elder, you really must because this now legendary book amongst traders deals with this topic in a lot of detail.
•When will I take my profits? Generally try to take incremental profits when you can. This is how professional traders run their business. Forex markets trend very well and what can often be seen is that traders snatch their profits when the big trend is just about to start and they miss on the big move. Don’t forget the golden rule: “The trend is your friend”. Let’s get a bit more specific here. Many traders ask the following questions regarding money management:
1. How to determine the optimum money management for a given sized account?
2. How to choose the best money management strategy based on the nature of the entry/exit methodology and back test results?
3. How can I design my own money management system that works for me and my style of trading?
Let’s try to address some of these questions.
You only have to be trading for a short period of time to realize that money management is more important than the method or system. If you tell new traders this, they just look at you blankly. All they want is a system and signals that they can trade the next day.
Money management is really that important. Now, determining what percentage of capital you should risk is actually a function of your hit rate. For example, if you win 80% of your trades consistently, then you could risk more than if you win 50% of your trades consistently. You also need to know the maximum amount you can trade. In order to do that, you need to know your maximum drawdown recovery rate.
Good money management can be summarized in 4 basic principles:
1. Always risk the smallest amount you can, working on the worst case scenario all the time. How much money would I need to stay in the game if I had X number of losses risking the amount I am just about to trade, with X being the maximum number of losses you have ever had trading the system.
2. Protect your capital. You must calculate your potential loss based on where you will place your stop loss.
3. Most traders stop trading because they run out of capital before they learn enough to make money. The main priority should be to live to fight another day and not lose money.
4. Using a stop loss is one of the things you can control. There is no right or wrong place to where you should place a stop loss. It all depends on your trading plan. If you used certain indicators to enter a trade, you will outline that in your trading plan. Similarly, you will outline where you will put your stop loss based on the guidelines you have set out in the trading plan. For example, you might say: “I am going to enter a trade every time indicator X did this”. “As soon as I place my trade, I am going to place my stop at Y”. To determine Y you must have come up with a plan and back tested how many times you made money without Y being hit.
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