Wednesday, December 19, 2007

Current Equity - $520.24, Forex Challenge Money Management

My trading is done for the day...,

It's a perfect time to talk a little about money management and how it applies to trading, and specifically how it applies to this Forex Challenge. 

There are tons of different schemes that have been invented for trading the markets with "special" money management so as to turn mediocre methods into higher performing methods. Some are better than others.

Why so many? Because of the difference position size can make on your trading outcome. If your winning trades consistently have smaller position size than your losing trades, you have a very hard road to overcome. That is the road almost all fixed fractional followers have to traverse. You lose, lose, and lose-- and each time drop by another fixed percentage of capital. Then, when you finally get a winner, you will definitely be trading a position that has less size than when you started before the losing series.

You will read something you've probably never read before..., right now!

All market methods do not have the same edge. So, why trade them as if they all have the same edge?

You will see people boldly state, "Never risk more than 1% per trade or you will lose all of your money." And that without knowing what you are risking your trading capital on. All trades are not created equal.

What if you were in possession of a special trading system, based on identifiable market tendencies that repeat over and over---that has a true profit factor of greater than 2.5 to 1 (wins $2.50 for every dollar risked) and a win rate over 60 percent? Proven over thousands of 'real' trades, not theoretical ones? Are you going to just risk 1% of your equity on that trade?  (Systems like this do exist!)

If you don't like making money, I guess you could.

It comes down to how much you know about your system or method and the edges available from it. Notice I said "edges".

Even with relatively simple-looking trading models like OneNightStand and FirstStrike, each trade is not created equal. If you just look at the total raw system outcomes (trades) that these methods produce, you could figure out an approximate profit factor, and undertrade that figure to allow for errors in calculations and actual trading costs. In fact, that would be the absolute minimum of due diligence you would have to do to consider trading with real money.

What if you "knew" something extra about a system that most examining traders might miss? "Knowing" that certain subsets of trades definitely had greater potential than others? Wouldn't that encourage your adjusting a larger size for those trades if you could quantify that greater edge?

Think about the game of Blackjack.

The ONLY reason that casinos fear professional blackjack players is because they can determine when they have the advantage over the house..., and monopolize that advantage by putting on larger bets. The professional counters are able to win consistently because they are more likely to win their largest bets and only have to put up with many small losses and small gains when the "house" has the advantage. Professionals only bet small when their edge is small or non-existent.

Traders should too if they can identify higher reward opportunities.

On this topic, I received another nice email from a subscriber: (Below the email is my reply)
One more quick question. With the 50:1 leverage, what is the current (Oanda) unit size that you use?
I understand that you are using your money management algorithm to determine that, but I am just trying to stay close to the result, that you publish. You mention a 0.5% to 4% range for equity risk per trade.
So what % equity risk per trade would give approximately the same result as your blog?
For you to get exactly the same results as my blog you would have to have my exact money management algorithm. Unfortunately for many, that is unavailable except to my professional clients. (Last year a trading company licensed my money management algorithm. It cost them $17,000, based on the size of their trading operation.  Additional note: They earned $200K more this year with it than without it, and had 20% smaller drawdowns.)

My position size is based directly proportional to the probabilities of the specific trade I am taking. As I am aware of the precise edge of my systems, I can be much more precise than someone who has the rules for the trade, but not the exact figures for its edge(s).

Advantage is in the advantage.

I understand your wishing to emulate my results. (I personally don't think it is a good idea though, for reasons I will mention a little lower) My best advice is to test the methodology to the degree that satisfies you as to having sufficient edge for you to trade, trade very small for a month or two, and then step up your size as you gain experience. Within a short time you will find a percentage that approximates my gains and losses, probably between .75% and 1.5% per trade.

I encourage you to do a lot of research on money management for trading systems. Ralph Vince has written some great books on the subject.

What you don't realize now is how bad future drawdowns can, and likely will be. 60%, 70%, 80% drawdowns or even more from time to time are possible. I would prefer that it wasn't so, but it is. I've been down this road before.

Start small, build up your ability to execute. The markets aren't going away anytime soon.

My Forex Challenge is for my own trading test and proof of concept.

I'm sure you've already realized that I am definitely not running a charity. This trading challenge is also not meant to be an advisory service for me to drag all the world's forex traders into a profitable state.

I am willing to show traders a way to success. It may appear to be somewhat simple, but it is definitely not going to be easy.

Have a great week, and holiday season.

Thanks for the note.

Thanks - M -

Well that is enough for now on this subject.

It would have been great if we hadn't gotten stopped out on the GBP/USD pair. By checking the price action on GBP/USD, if we had kept reinstating the sell side after getting stopped out the first time, we would have been stopped out 2 consecutive times before the big move down. 180 pips in losses before having a slim chance to recoup some of the equity lost. That is the way trading goes. It is all about probabilities.

Joel Rensink

PS: To receive the FREE! trading rules for the Infiniteyield Forex Challenge ($499 value) and the semi-monthly newsletter about this challenge, send an email to: and tell me the address where you would like it sent.

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