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Money Management 101
Money Management 101 (draft)
Keys to survival for newbie?s
trading Futures
95% of all traders loose money and quit. The reason varies, and I won?t get into the psychological aspects around fear and hope here (that is covered in so many other documents in the past). Instead I would like you to focus on the logics behind Money Management. I will put in my view on MINIMAL factors for survival - in some cases I am deliberately conservative - to protect your risk exposure.
You need to understand and learn following terms and factors POSITION SIZE, PERCENT PROFITABLE, RISK/REWARD RATIO, STOP LOSS, MARGIN REQUIREMENTS, DRAW DOWN and then be able to calculate the survival balance between these factors. Because all these factors depend on each other.
POSITION SIZE and MARGIN REQUEREMENTS
As a newbie you should not trade at all until you have been paper trading for at least three months. During that period you need to record all trades and calculate your winning percentage. If it?s less than 50% profitable - you don?t have to read any further. Just quit here and now, and go back to you regular day job.
Be very careful if you have extensive periods of looser in a row (more than 5), because that will affect your account in a very negative way and it´s called DRAW DOWN. As a general guide your maximum DRAW DOWN should never be more than 10% of your account balance. The maximal loss per trade should never be more than 2% of your account balance (some professionals even use 1-1.5% as maximum).
Consequently the maximum POSITION SIZE should be related to your account size AND your STOP LOSS amount.
The day trading margin is today $500 per contract (Mini-DOW YM). That means that you can trade one contract with only $500 in your account. Should you? - NO!
I believe that it?s REQUIRED to use 6 times larger MINIMAL MARGIN to day trade one contract (i.e. $3000). That means that your maximal STOP LOSS with one contract on YM should be 12 points. Because 2% of $3000 equals to $60. And every point on YM is worth $5. 12 points times $5 is $60?
RISK/REWARD
The normal and general accepted ratio between wins and losses is 2:1. That means that your winners must be 2 times bigger than your losses. This is called the RISK/REWARD RATIO (r/r). I strongly suggest that you stick to the normal 2:1 ratio.
The theory behind this ratio is a mathematical exercise where the MINIMAL survival factor is 1.6 (i.e. r/r 1.6:1).
Example 1 (conservative):
Assuming we have a 50% profitable system (or method) and calculating with 10 trades. Using a 10 tick stop, and 16 tick profit target.
5 losses x 10 ticks = 50 tick gross loss
5 winns x 16 tick = 80 tick gross winn
Net profit would then be 30 tick
Example 2 (normal):
Assuming we have a 60% profitable system (or method) and calculating with 10 trades. Using a 10 tick stop, and 16 tick profit target.
4 losses x 10 ticks = 40 tick gross loss
6 winns x 16 tick = 96 tick gross winn
Net profit would then be 56 tick
Example 3 (scary ratio of 5:8):
Assuming we have a 50% profitable system (or method) and calculating with 10 trades. Using an 8 tick stop, and a 5 tick profit target.
5 losses x 8 ticks = 40 tick gross loss
5 winns x 5 tick = 25 tick gross winn
Net loss would then be 15 tick
Above examples doesn´t include slippage and commission. That will add extra costs to the net wins/losses. Also - these examples where calculated with MINIMAL ratio - you should use the normal 2:1 ratio.
"RUNNERS" and bracket setups
I?ll bet that you have read and listened to people who talks about runners and taking partial profit. Those techniques are not covered in this basic guide. But I would like to share some of my thoughts on the subject.
You should be very careful with these setups. The first step is to "shadow"-trade an extra contract on paper while you make your regular 2:1 trades (with regular - I mean all in/all exit - regardless of how many contracts you trade). That will give you an idea about the impact on your account.
As a first rule - if you decide to split your trade lots in two - and exit half on a pre set profit target. The stop on the remaining half must be moved to break even. Unfortunately this can become a "zero sum play" unless you baby sit the remainder with some sort of logical trailing stop.
Example 4 (no move to b/e):
Assuming we have a 50% profitable system (or method) and calculating with 10 trades. Using a 10 tick stop, and 16 tick profit target with 2 contracts.
2c x 5 losses x 10 ticks = 100 tick gross loss
1c x 5 winns x 16 tick = 80 tick gross profit (half the position)
1c x 5 losses x 10 tick = 50 tick gross loss (other half)
Net loss would then be 30 tick
Example 5 (move stop to b/e when profit target hit):
Assuming we have a 50% profitable system (or method) and calculating with 10 trades. Using a 10 tick stop, and 16 tick profit target with 2 contracts.
2c x 5 losses x 10 ticks = 100 tick gross loss
1c x 5 winns x 16 tick = 80 tick gross profit (half the position)
1c x 5 b/e x 10 tick = 0 tick (other half)
Net profit would then be 20 tick
OK? Compare that with a normal all in/all out example with 2 contracts.
Example 6 (conservative w 2 contracts):
Assuming we have a 50% profitable system (or method) and calculating with 10 trades. Using a 10 tick stop, and 16 tick profit target.
2c x 5 losses x 10 ticks = 100 tick gross loss
2c x 5 winns x 16 tick = 160 tick gross profit
Net profit would then be 60 tick
Bottom line - DON`T play the partial profit game until you know exactly what impact it has on your account, with your trading style and your track record.
In my humble opinion - Keeping "one runner", assumes that you trade more than 5 contracts and know what you are doing. As a newbie you should focus on the basic Money Management and stay with your plan and minimal risk exposure.
Woodie´s CCI style trading
Finally I would like to point at that trading by Woodie´s rules takes al lot of this burden away. If you stick to it. You will probably not meet your Money Management stops. And small stops combined with his great exits take care of the basic "survival levels". That doesn?t mean that you can ignore to learn the basics. Because you are responsible to validate both your plan and execution. If it doesn?t fit within above Money Management - you have a problem.
Happy trading!
Best regards
"Therookie"
PS. This is a working document - any comments and suggestions are most welcome. Even contradicting ideas, as long as your focus are on helping newbie?s ;O) DS.
therookie
2004-12-16 07:27:00
Mycket bra inlägg! Funderar lite på de exempel du visar. I exempel 1 så räknar du med en stop på 10 tick och profit target på 16, men borde man inte snarare räkna på snittförlust/vinst för att få mer korrekta siffror? Ofta har man ju t.ex. 10 tick som initial stop, men flyttar med den ganska så snabbt vilket gör att snittförlusten blir lägre och ger andra siffror. evilsteff
2005-02-13 11:50:05
Inlägg om money management kan man aldrig få för många av. Korrekt MM kan göra underverk med din portfölj. Mycket bra inlägg. snyggot
2005-02-13 12:09:53
#1 Ja och nej - primär anledning till att jag beskriver detta i denna exempelform är ju för att åskådliggöra skillnader, men fortfarande jämföra "äpplen med äpplen". Därför anser jag att exemplen är korrekt uppställda. MEN i praktiken har du rätt i att det blir andra siffror beroende på individuella metoder. Fast fortfarande är det viktigt att den genomsnittliga vinstration är minst 2:1 över en längre period (alternativt fler antal trades). Mvh/Therookie therookie
2005-02-13 12:14:27
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