I hope you’re enjoying the sunshine.
I must admit staring out of the window at blue skies does make it hard to concentrate on your trading. Even in London, people seem to have relaxed a bit more. I swear I even saw someone smile on the tube the other day.
Trading can be a real test of mental discipline and that’s been ever true this week as I struggle to get back into my flow following a lovely weekend in Devon. Needless to say I wasn’t exactly on the ball yesterday, making some sloppy trades and taking some small losses.
However, I’ve been doing this long enough to know how to keep my losses small on my bad days. I’ve painful first hand experience of how quickly things can unravel if you do not do this. To make money trading you have to have good money management and know when to trade and when to hold back.
Make money trading with consistency and risk management
I think when I first got into trading I thought it was all about the rush, the excitement the bravado, but the more I have been trading, the more I’ve realised its more about the less exciting things such as discipline and concentration.
To use a football team analogy, it’s not about being the super striker, it’s more like being a top defender. A defender has to concentrate throughout the whole match even if most of the action is at the other end. All it takes is just one lapse for the other team to score a soft goal.
Consistency and risk management are the hallmarks of top traders. I don’t watch much football, but I’ve seen enough to know that putting a fancy player like Cristiano Ronaldo as your centre back won’t make your goal keeper too happy.
The best way to manage your risks is to make sure that you have an idiot-proof money management plan. I say idiot proof because there is nothing like money to make you do stupid things. It’s easy to be rational when looking at a trading situation from the comfort of hindsight, but when you’re in the thick of things with real money at risk, you can end up making the strangest decisions.
If your money management rules are clear from the outset then you less little room for the stupid part of your brain to step in and take control.
How to create a money-management plan
The first part to any money management plan is to decide on how much of your trading capital you are going to put at risk with any trade.
Sensible levels of risk vary between 0.5% to 2% of your trading capital as your initial risk. Your initial risk is amount of your trading pot that you are prepared to lose on one trade. This means that in the worst case theoretically you will lose between 0.5% and 2% of your account on any one trade. In practice, you could sometimes lose more than this as markets jump over your stops, but it’s not a bad marker.
Here are some examples:
With a £2,000 account 0.5% initial risk would be £10
With a £2,000 account 1% initial risk would be £20
With a £2,000 account 2% initial risk would be £40
Why risk as little as 0.5%?
The point of risking so little is to stay in the game long enough to survive the harsh learning curve.
0.5% risk means you can afford to make 200 losing trades. 1% risk means you can afford to make 100 losing trades. 2% risk means you can afford to make 50 losing trades.
Risking less obviously means that you win less money, but it could be the best place to start for newcomers.
Your next step is to calculate how much you will risk per point if spread betting (or how many shares to purchase if trading equities). This of course depends on the type of stop you are using.
If you are using a fixed 10-point stop on every trade then you will risk the same amount per point on every trade. I’ll get on to compounding another time, my preference is to keep stakes the same over a month.
With a £2,000 account, you’d risk the following amounts with a 10-point stop.
0.5% risk: £1 per point
1% risk: £2 per point
2% risk: £4 per point.
However, many trading systems such as UFXP use volatility based stops which mean that trades with preceding larger moves use much larger stops than trades with preceding smaller moves.
This means your initial stop might be 20 points, or it might be 5. In my opinion the best action is to keep your initial risk the same in terms of how much you are risking in total on the trade but change what this means per point.
Therefore you will be risking the same % of your account whether your stop is 5 points or 100 points, the only thing that changes is the amount you put on per point.
Here’s an example
Lets say you have £2,000 in your account and are willing to risk 1% of your account on any trade, this would mean a total risk of £20.
If your initial stop is 20 points away you would risk £1 per point. That’s your £20 risk divided by the size of your stop. £20 divided by 20 = £1 per point.
If your initial stop is 10 points away you would risk £2 per point. That’s your £20 risk divided by the size of your stop. £20 divided by 10 = £2 per point.
In both these instances your initial risk is exactly the same but your potential for gain is dramatically different. With a wide stop you are giving yourself room for some volatility which means you are less likely to be stopped out by any annoying whipsaws, but you are sacrificing some profits on the trade if it goes well because you have less on per point. With a tight stop you are more likely to be stopped out, but if it goes your way, you will be highly rewarded.
This morning there was a short signal on GBP/ USD on the 5 minute chart with an initial risk of 42 points, due to a bigger move leading into the trade. There was also a short on EUR/ USD with an initial risk of 14 points due to a smaller move going into the trade. Using a 5,000 account and risking 1% of your account per trade you’d risk £50 in total on both trades, but put different amounts on per point.
On the GBP/ USD trade you would risk £50 divided by 42 points (your initial stop), meaning you’d place £1.19 per point. On the EUR/ USD trade you’d risk £50 divided by 14, meaning you’d place £3.57 per point.
At the time of writing the GBP/ USD trade was making 40 points, assuming we exit here due to the trailing stop, you would make £1.19 X 40 points or £47.60. However, the EUR/ USD trade has been stopped out for a 30 point profit resulting in a gain of £107.10 (£3.57 X 30 points). Less points made, but more money in the bank thanks to the greater amount put on that trade.
I hope this helps you manage your risks better than I did when I first started trading.
Another great week with my UFXP trades – I managed 170 pips over the week including the two trades mentioned above. I’m still very impressed with the system and believe that using the trailing stop method and not the scalping strategy is the best way forward, especially once you factor in the spread.
As mentioned above, you still need all the elements of a good defender in football; namely patience, discipline and risk management. In my experience the system is typified by some profits, some losses followed some big winners that make all the difference. If you give up after a few trades that don’t go your way, you’d miss out on the big moves that you need to make your profits. I’ve just been trading GBP/ USD and EUR/ USD with some on the GBP/ EUR because I’m more familiar with these markets.
Elsewhere, my short on the S&P 500 futures is continuing to test my patience. My stop is above the high on the 2nd of 1427 and was nearly hit as the market rose last Tuesday. Thankfully, we sold off on Wednesday, but have been bumbling around since. I’ve moved my stop to break even and have resisted booking the small profits because I still think there’s more room on the down side. Famous last worst, lets hope the curse of the Market Maven email doesn’t hit me again!
This week’s hot trading buttons
Lots of US data this week. We’ve got Bernanke Speaking at 1.20 today, then retails sales a few minutes later. Last week, Wal-Mart and a few other big box retailers announced that their ‘same store’ sales were higher, possibly indicating that consumers are shopping more. If this is the case then perhaps this could be the stimulus that the US president was talking about, or maybe it could be explained by consumers hitting the shops to spend their tax refunds.
Tomorrow at 10.30 we have the Bank of England inflation report which will no doubt cause some more miserable headlines about price inflation. I’ve a hunch these figures could continue to be worse than expected.
On Thursday, the main market mover will be Bernanke again speaking at 2.30. All in all it looks like it will be one busy week, particularly on the currency markets with big announcements from all corners of the world.
“Markets are constantly in a state of uncertainty and flux and money is made by discounting the obvious and betting on the unexpected.” George Soros.