Managing risk is one of the facets of trading that many including myself still struggle with. I continually have to resist the urge to add one more lot to a Forex trade, or one more contract to an options trade. I also have to fight off that quick "what if" thought that I have whenever I have a successful trade. I make the mistake of thinking how much more I would have if I had added that one lot or contract.
I started trading in 2009 with common stock, and then moved to options in 2010. I'll be the first to say that my trading style is erratic. I have made attempts to formulate consistent strategies, but due to employment and other life factors, in this I have been unsuccessful. This haphazardness nearly blew me out when I first started trading. I was lucky to have unwound my losing position (yes one position nearly destroyed my account), with 65% of my account left. I would have a trade idea and put it on. Then another and another until I was leveraged to the hilt.
One of the most ground breaking discoveries I had in my own trading was after I became involved in the Forex market. That you can trade smaller amounts, and make more money. My Broker is very good about making educational resources available to new traders. The tutorial videos for trend following and risk management from DailyFx are all over YouTube. There are daily articles about setups and stops, technical analysis and outlooks and many other resources for those that trade currencies and gold.
Contrary to what seems to be popular belief, I don't personally think that my broker is out to bamboozle me out of every last cent or yen by stacking the market against me. That makes no sense at all from a commission based, or spread based profit model. Brokers know that they make more money over the long term by cultivating an atmosphere of trust in the trading tools and advice provided, and by producing significant numbers of competent, active traders that are successful and pay commissions or spreads for life. It's a subscription business model. A magazine publisher would not expect to make a fortune by selling a magazine that a reader would only want one issue of, that further causes the reader to hate the publisher, and would result in that reader not buying a magazine from any publisher. The reader would suffer, the publisher would suffer, the publishing industry would suffer in this example.
So for Forex trades, I limit myself to 5% total risk exposure at any one time. Most of my trades are around 2.5%, and I rarely have more than two trades on at any one time. If I do, it's because one of them is well in the money being tended to with a trailing stop, also in the money. Even if I get 10 trades wrong in row, I'm still in the game.
I use the same rule for options trades. For example, working with $50,000 capital, 5% risk is $2500. This should be your max at risk for all open option positions in an account of this size.
Keeping it small time, If your micro account had $200 of trading capital, 100 pips of risk on a single lot is 5% of your capital. Same for a mini lot for a $2000 account, or a single standard lot on a $20,000 account.
Here's how that works with a couple of my recent trades:
Using my personal 2.5% limit, I went long EUR/USD at 1.297 with a stop at 1.292, targeting 1.31. There was 50 pips on the line, or $5 in a micro account of $200. If I was to get burned for a full stop, I would still have 97.5% percent of my trading capital remaining.
I closed out at 1.31 for 127 pips. My account now sits at $214. I can now risk 107 pips and be within the 5% rule.
In the options market, I purchased a TIF Jan 18 '14 $72.50 call for $9.85. Now, the way my equity portfolio is layed out, I am roughly 65% in stock positions and bond funds with 35% in tradeable cash. The $985 I have at risk in the call is about 3% of the portfolio value.
I have one other options position in GNC, but having paid for it by selling options that are closed, only profit is at risk.
My trading focus lately is on finding better trades, increasing my batting average and reducing blowout risk to the extent possible in my accounts.
Follow me on twitter @B50cal1978.
Please leave a comment if something in the article strikes your fancy.
Thanks for your time,
STT
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