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3 Keys to Proper Trade Management
Today we take a look deeper into the world of proper trade management. This is a VERY important
aspect that EVERY trader needs to consider, from new traders to old. Unfortunately several traders don’t pay attention to this part until AFTER they have blown an account or more out.
1. Risk-Tolerance
The first thing you need to do is take your account size and
multiply it by 3%. This will tell you what your goal for risk on each trade
should be.
Note: Smaller trade accounts, such as $2,000 trade accounts
will often need to use up to 5% risk per trade, which is one of the reasons why
smaller accounts struggle sometimes to make profit…they have to risk to much
on each trade and only a few losses can blow the account.
Note: The less risk, the better. If you can risk only 2% of
the account you are much better off.
Think of the numbers behind this. If I am risking 3% of my
account, and I have a positive expectancy of 70% on my trades… I know that 30
out of 100 trades will be losses, and if I am only risking 3% of my account I
will be able to absorb those losses on the way to having 70 of those trades as
winners.
example: a $5,000 trade account would risk $150 (3%) on each
trade, which means 15-ticks of risk on Crude, Gold, or Russell.
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2. Risk/Reward
Once you know your risk-tolerance to your specific account
size, now you need to make sure each trade you take has the proper risk/reward
ratio.
Very simple. I want to risk less than my expected reward.
We strive for a risk/reward ratio that is great than 1:3,
meaning that we will risk $100 to earn $300, or 10 ticks to make at least
30-ticks.
Assuming we have a 70% Positive Expectancy on our trades, we
will take 30 losses and 70 winners for every 100 trades we take. I want to make
sure that the losses we take are small, and the winners are large. This example
would result in make profit above the amount of the losses.
Example: Risk $100, Earn $300
30 Losses @ $100 each = – $3000
70 Winners @ $300 each = + $21,000
Net Profit on the account = + $18,000
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3. Position Size
Now that we know how much we want to risk per trade (based on
account size) and we know that we are risking 1/3 of our reward on each
trade…now we need to adapt to each entry pattern we get for each trade.
Although we use the same ‘entry patterns’ to take each trade,
usually each pattern is slightly different, so one-size does NOT fit-all when
it comes to your stop loss on each pattern.
Because your stop-loss will be slightly different on each
trade, each trade will have different amounts of risk, so we need to adjust our
position size.
Remember, we only want to risk 3% of the account, let’s use a
$5,000 account as an example, with a max risk of $150 per trade.
Examples for Position Size: Crude Oil / Gold / Russell
= $10/tick
Entry Pattern #1
Requires a 5-tick stop loss
5-tick stop-loss = $50 risk per contract
I can risk $150 per trade
I can trade 3-contracts (3 x $50 = $150)
Entry Pattern #2
Requires a 7-tick stop loss
7-tick stop-loss = $70 risk per contract
I can risk $150 per trade
I can trade 2-contracts (2 x $70 = $140)
Entry Pattern #3
Requires a 10-tick stop loss
10-tick stop-loss = $100 risk per contract
I can risk $150 per trade
I can trade 1-contract (1 x $100 = $100)
(2 x $100 = $200 = 2-contracts has too much risk)
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QUESTIONS?
As a member of SOT you will be trained on proper
risk-management, trade-management, position size, as well as trader psychology
to avoid the common pitfalls that happen to most new traders.
Managing Risk is the most important aspect of your trading
career…not fancy indicators, bells and whistles. Protect your capital, stay
alive while you master this skill, and prosper!
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