We talked about one way of timing an entry (after the Spinning Top candlestick formed near the resistance line we went short). We also talked about where to exit the trade if profitable (near the opposite support line) and where to exit at a loss (above resistance line).
But what about how much to risk? How large a position do you put on? How many pairs do you trade simultaneously? These are actually the more important questions.
You see the simple fact of the matter is that trading is and only ever will be a pure numbers game.
A good analogy is the coin-toss. We all know that the odds of any individual toss coming up heads or tails is 50/50. But what are the odds of the coin landing on the same side 6 or 7 times in a row? If you toss the coin long enough, the odds are pretty good that you can get those kind of streaks.
Here's an enlightening statistical chart that drives the point home as it relates to trading:
Print this chart and put it somewhere that you will always see it. Use it to remind yourself that even the most robust systems will have losing streaks. Depending on the nature of the system, many professional traders' winning trades account for about 40-50%. Looking at the table, you can see that over the course of 50 trades there is about a 30% chance that the trader will hit a streak of 6 consecutive losses.
Once you get used to support and resistance trading your accuracy can go as high 60-70%. But even at 60% accuracy you run about a 17% chance of hitting 6 consecutive losses over your next 50 trades.
It is not even a question of if you hit a losing spell...it's WHEN you hit it!
What do you do then if your otherwise robust system hits a losing streak and you're risking 15-20-25% of your account on each trade? BUST!!!! You have a great system that can do well for you but you lost because you were risking too much!
How on earth are you supposed to make money then, you ask? How do professional traders do it then if some of them have only 40% winning trades?
Simple...proper money management (AKA risk management)! They hold on to their winning trades long enough such that over a long series of trades, the value of their winners far outweigh the value of their losers. In other words, if a trader is only winning 40% of the time but his winners are worth, on average, $200 and his losses are worth only $75, then the trader is making money over time. That's the real secret!!! The pros aren't trading for accuracy nearly as much as they are trading to ensure the VALUE of winners outweighs the losers.
They also trade position sizes (lots or contract sizes) small enough to ensure that they survive the eventual losing streak.
Traders make millions in spite of poor accuracy because they have the discipline to respect the relationship between what they risk on a trade and what they stand to gain. They never look at either factor in isolation. They will have the discipline to let a trade go if the potential gain is too little in relation to what they stand to lose. You have to be able to do the same.
It's hard because we are psychologically wired to want to be right all the time. But as i hope you are beginning to understand, successful trading is NOT about being right all the time...it's about making as much as you can when you are right and losing as little as you can when you're not. So, how do you get over this psychological dilemma? It's surprisingly easier than you think but the answer goes beyond the scope of this particular post (...to be continued...)
So, the bottom line question: How much should i risk on my trades?
The answer will largely depend on how robust your system is (which i will be discussing in a future post on testing) but it is safe to say that a beginner should be risking nothing more than 1% of his account value on any single trade.
In the next post, i'll introduce specific styles of money management. You decide which one is best for you. It doesn't really matter as long as some form money management is actually put to use. I will also show you a neat little tool to help you calculate your contract sizes given your account balance, % risk you want to take, and your established stop loss level.
Posts
No comments:
Post a Comment