money management

[muddeman]

Hi Edward, I have just registered with FSF, having visited this website on numerous occasions in the past for useful tips of successful trading. I would like to congratulate you on providing an excellent service for new aspiring amateur traders like myself!
When I think of all the people out there charging extortionate sums of money for providing a 'trading signals' service or for trading strategy, most of which do not provide consistent profitability, it is really refreshing to know that your website provides good honest trading strategies free of charge!
I'm afraid at this stage I don't have a strategy to share with other members as I am still learning myself, but one thing did occur to me as to why only a small percentage of traders are successful, and it is a thought I would like to share with other members.

In theory, setting aside for a moment fundamental and technical analysis, there is a 50/50 probability of winning a trade. After all a particular market can only go up or down, so you might expect 50% of traders to be successful and the other 50% not. And yet the consensus is that most of us are unsuccessful.
Surely it can only be down to poor money management. Taking profits too soon and not cutting losses quickly enough, when we should be doing the reverse.
I do feel money management is the most understated aspect of trading. I have read several books by expert traders and they all say without exception that you should always aim for a profit/risk ratio of at least 3:1, and never stake more than 5% of your trading strategy on any particular trade. Using this ratio you can afford to be wrong 60% of the time and still make a profit long-term.
This I feel is something we should all be aware of.

Charles

[JimmyMac]

there is a 50/50 probability of winning a trade. After all a particular market can only go up or down, so you might expect 50% of traders to be successful and the other 50% not. And yet the consensus is that most of us are unsuccessful.

Most non-professional traders place bets in markets totally devoid of any kind of solid trading model structure or foundation to begin with.
They have no idea how financial markets really work, who & what drives & influences them, or even when the most favorable time exists to attempt to trade their market.
Half the battle is to recognize when the odds of a successful outcome are weighted more in your favor than not. That entails a very detailed understanding of your (market) surroundings & the trading vehicle you're using to work it.

The vast majority of novices trip up due to a complete lack of correct preparation, training & capital.
Discipline & focus are also low on the list of priorities.

Surely it can only be down to poor money management. Taking profits too soon and not cutting losses quickly enough, when we should be doing the reverse.

You can have the best money management tool in the industry at your disposal, but if you can't prepare, construct or time a trade to save your life, you might just as well toss that MM tool in the trash.
If all you needed was a decent money management matrix to get the job done, everyone would be bumping heads on the sun loungers of the Bahama beach front!

[muddeman]

Stacking the odds in your favour so that you win the trade is obviously important, whatever technical or fundamental strategy you use, but with careful money management (i.e 3:1 profit:loss ratio) you can lose 60% of the time and still come out on top in the long run.

[JimmyMac]

...but with careful money management (i.e 3:1 profit:loss ratio) you can lose 60% of the time and still come out on top in the long run.

The armchair theorists paint a pretty picture don't they. Boy I'd love to live permanently in their world.
Unfortunately we trade & slug it out in the real world, & you'll find that one just a tad less accommodating & unforgiving.

[muddeman]

You sound like the voice of experience. Have you been trading long? (excuse the pun) What strategies do you use?

[JimmyMac]

Have you been trading long? (excuse the pun)

Pun excused
Too damn long for my liking
Going on 16 years come October.

What strategies do you use?

These days I specialize.
The guys I work with are jobbers. We basically trade short-range directional momentum plays via the spot market.
You can get a feel for the types of bets & market deals we dial in & out of by taking a walk thru this thread from around page 5 onward.
It's pretty close (technically) to the styles of models we operate.
combination-strategies-t140-200.html

[muddeman]

Hi again, what time frames do you use for the directional momentum trades?
I've heard it's best to use two time-frames, the larger one to identify the trend and the shorter one to time the entry point.
What indicator would you suggest for timing the entry point? Using the SAR parabolic on the smaller time-frame seems to be a good entry timer when you get a colour change, or do you use moving averages to time the entry point.
Thanks

[JimmyMac]

what time frames do you use for the directional momentum trades?
I've heard it's best to use two time-frames, the larger one to identify the trend and the shorter one to time the entry point.

Dual or combination timeframe deployment is one way to get the job done, sure.

Providing you're suited to that type of trade execution, your own personal combinations will pivot around your risk attitude, style preference & objectives.
That's the bit where you're going to require to roll your sleeves up, decide on what your objectives are & begin experimenting with the available timeframe options.

What suits one, doesn't necessarily suit another.

What indicator would you suggest for timing the entry point?

We don't utilize indicators muddeman, so you're going to have to seek assistance elsewhere on that one I'm afraid.
Indicators can't show us anything we don't already see by observing the technical footprints of the price behavior.

Carll, & I believe Jack, two of the posters on the thread I recommended you take a look at, use a stochastic hook in sync with the primary bias as a secondary confirmer at levels of importance, but that's about as far as it goes.

[KajolThappar]

Yes, cannot stress that enough. Everyone who really trades forex will tell you this.
Think of it this way. You have $10,000 in your FX account. If you have 100:1 leverage ratio, you're controlling $100,000 with $1,000 of your own money, so you can lose more than your initial bet. Everyone tells you to be careful, because you can get wiped out in a few hours if you screw up.

Here's a more common scenario--happened to me. You get into FX, win some, lose a few, nothing major. I had about $4000 in my account. I usually use really low leverage (20:1 or so, low for retail FX), to play it safe. But I was nailing trade after trade, and made about a grand in a few days. So late at night, I hopped into a trade, determined to make another hundred bucks or so before I brushed my teeth and went to bed.
Instead, my position went sour, and started dropping like a stone. I had never seen it drop so quick, and I was in the hole about $150 after about 1 minute, so I bought more, to drop down my average price, and more, but it kept going down. After a stressful 2 hours or so of rising a bit, but staying negative, I eventually cased out and lost $2000. Half of my account.

It sounds dumb, eh? But its human nature. On wall street or in London, the Big traders, after they score a big one, like a trade that nets 300% or something like that, are forced to take a vacation from trading for a while, so I hear. The reason is that winning big gives you a feeling of invincibility.

Anyway, sorry for the boring story, here are some tips I wish someone would have given to me.

1. A demo account and a live account are completely different. Having real money in the game changes everything.
2. The first book you should read--before losing or making any money, is one about Trading psychology. Understanding your strengths, weaknesses, and common reactions--things like fear, greed, caution, patience--knowing these will save you and may even make you a fortune.
3. Money management is simply self discipline. A good rule for beginners is you should never wager more than 1 or 2 or at most 3% of your equity (real money) on any one trade. Like $10000, you have to put stop losses on your trades so a loss is never more than $100 or $150 or so. Enforce that rule, put bad trades out their misery.


Money management, and an understanding of the basics of trading--psychology, probability (Risk-reward), technical analysis, understanding the software you'll be using (or trading platform)---these things are way more important than being a financial genius, or being able to predict the future.
That's why a 20 year old kid in Sweden with a computer can outperform every hedge fund in the world. Just making probability and self discipline work for you. You don't need to be George Soros.

[SharpForex]

A 3:1 ratio is a wonderful concept, if only the market would co-operate! I began trading financial futures in 1983, and have had 27 years to read all those books, hints, and tips about money management. They all suggest a robust risk/reward, but fail to provide a practical and consistent method for identifying such trades. The fact is markets, whether futures, options, shares, or forex, don't give clear signposts so the 3:1 ratio becomes simply an abitrary and often meaningless point on a chart.

In my view, money management is about controlling losses. None of us can predict profits, but we can be 100% certain of the losses we are able to absorb BEFORE we enter a trade. This is embodied within the stop-loss. But where do we place the stop-loss? At nearest support / resistance, of course!

Money management and market analysis co-exist. Analsysis provides logical support / resistance locations at which stop-loss orders may be set. The distance between the stop-loss and the proposed entry price is the risk exposure. This risk exposure maybe equal to or less, but not more, than the pre-determined percentage of capital you are prepared to risk. Lot size is determined by dividing the pre-determined percentage of capital you are prepared to risk by risk exposure, rounded to the nearest whole lot.

For example, say you have a $1,000 account balance and you set 2% ($20) as the pre-determined percentage of capital you are prepared to risk. Let's say the $20 risk capital equates to 200 pips at 10-cents per pip (Micro). The distance between the stop-loss and the proposed entry price is, say, 65 pips. Lot size is calculated by dividing risk capital (200 pips) by stop-loss risk exposure (65 pips), resulting in 0.0307 or 3 micro lots for this trade. This strategy allows lot size to adjust to risk levels (high risk = low lot size, low risk = high lot size) and ensures that losses CANNOT exceed your pre-determined percentage of capital to risk.

A 2% risk setting allows a minimum 50 losing trades before account funds are depleted. Your trading log will identify for you the number of winning and losing trades over a period of time, along with the average profit per profitable trade and average losses per losing trade. Let's say that you win 1 trade in 3, with an average $50 per winning trade and $20 per losing trade. Over 50 trades the results will be: 16 win trades @ $50 = $800 profit against 34 losing trades @ $20 = $680 loss, for a gain of $120 net.

Your trading log will enable you to identify most profitable trades. You can use this information to improve your trading performance. For example, your log may identify a particular currency pair or technical indicator combination that generates best results, allowing you to focus future trades. Improving your batting average from 1 in 3 to 1 in 2 would increase the $120 net profit above to a $750 net profit.