Most of us are obsessed with finding the perfect trading method that will yield us the highest win rate and point total.

While it's very important to have a high expectancy trading system, it's even more important to have a profitable money management system.

That's pretty much the dirty little secret of it all. You can have 100 wins and 30 losers and still be in the negative with the wrong money management. However, armed with the right money & risk management, you could be wildly successful.

In fact, you can take what appear to be losing systems and with the correct money management methodology turn them into profitable ones!

There are 3 parts at work here:

• Trading System - How & when to trade.
• Equity Models - How much you actually have.
• Money Management Methods - How much & which to trade.

Let's start with the trading system, the goal with any system should be to design and develop a high expectancy trading system.

How do you define "high expectancy?"
Expectancy = (Probability of Winning * Average Win) Minus (Probability of Losing l , Average Loss)

The primary variables that control the system are:

• Entry technique that will yield highest possible winning rate
• An initial stop loss that preserves your capital
• Exit strategy that will capture as much profit as possible from the market

Those are the basics and what you are trying to determine is what your win/loss % and reward/risk ratio then you can design a money management model that will work for the system.

I'll cover money management next week. Boarding a plane to Asia and need coffee... haha

__________________
-David T-
Verbtheory Trading Journal
-----------------------------------------------
When time is short, timing is everything.
In such an environment, technical analysis comes into it's own.

So how much do you have in your account to trade with?

That's what equity is all about. It isn't your account balance. It's how much free capital you have after subtracting open profit & loss. In fact, there are several different ways to calculate it.

• Balance (Basic)
  Equity = Current Account Balance
• Core Equity Model
  Equity = Available Equity – Total Allocated Open Position Risk based on Initial Stop Loss value
• Total Equity Model
  Equity = Available Equity + Total Allocated Open Position Risk based on Initial Stop Loss value
• Reduced Total Equity Model
  Equity = Available Equity + Total Open Position Risk based on Current Stop Loss value (this takes into account stop losses that have been moved or trailed thereby reducing our risk, increasing our equity and enabling us to take on more positions)

This makes a big difference then just looking at the account balance and figuring 2% is what you're going to risk. 2% of equity means something completely different and will reduce your maximum exposure to the market.

Think on these things and then I'll discuss Money Management methods next. When you combine money management and an equity model that suits your method of trading you may surprise yourself.

__________________
-David T-
Verbtheory Trading Journal
-----------------------------------------------
When time is short, timing is everything.
In such an environment, technical analysis comes into it's own.

Great stuff verb.

Yeah many people do not realize that once you move a stop to BE then you can risk another two percent or whatever your risk tolerance may be. That trade is now risk free so you can begin looking for another quality trade.

Although my method is a little unorthodox is relies heavily on management.

Without money management you might as well go to the casino and put it all on black. Its more important than looking for X squiggly crossing over Y and then waiting for price to reach line B.

It's so important that it should be taught FIRST before learning to cross squigglies.

__________________

Forex Auto Pilot: SUPERCHARGED is here!
10% to 40% returns per week.
Click here to report for duty!

Ok thanks for everyone's patience, my quant project is taking much of my cycles but back to the program.

So now that we have a good understanding of equity models, how much should you risk per trade?

That all depends on the method you employ to fit the type of exposure your willing to take on.

For example, many folks on this board use EA's. When you conduct backtests, you can see the EA have periods of drawdown called relative drawdown. This period, RDD for short, is the period in which you will experience trades that are in the negative and are "hanging" on for dear life. If the market moves against you too much then you could be either stopped or worse yet, margin called. If the dealer margin calls you then its game over and they will liquidate your positions according to their retail agreement with you (which you would have signed when you deposited your funds with them).

How do you avoid the margin call? Simple, control how much you trade.

The other reason to control exactly how much you trade is because when it comes down to it. It is the ONLY thing you CAN control. FOREX is a huge market and your 0.1 lot trade is going to get pushed around by the big boys either hunting for stops, counter-trading against you or even just the randomness of a big US corporation buying another company (M&A = mergers & acquisitions) and needing $100million euros to do it. That one exchange of USD to EURO could have a devastating effect on your position IF you traded too much and there was not enough margin in your account. This process is called controlling your maxium risk exposure.

So the terminology we will use is:

• Maximum Risk Exposure:
  Simply put this is the maximum amount of money that you are willing to have exposed at any one time while trading. The key here is to figure out how much you can tolerate and more importantly, how much your dealer can tolerate. Check your dealer's margin requirement, it's the small lettering that say's we will liquidate your positions if your available margin falls below this percentage. In truth, this is how the dealer's make their money. By overextending yourself on trades, you play right into their hands. And as soon as your free margin falls below their stated level, they will liquidate you with extreme joy. Another retail trader bites the dust! In MT4, you can see the free margin avaiable in the bottom of the terminal screen.
• Relative Drawdown (RDD)
  This is basically the amount of negative drawdown you feel comfortable with before going nuts and affecting your psyche. Generally speaking a 30% relative drawdown is reasonable, meaning that you could be in the negative with open positions accounting for up to 30% of your equity.
• Risk Per Trade
  This is the maximum % of your equity that you are willing to take on any one trade. The total open positions defines your exposure, so if you had 5 positions open with 2% risk each then your maximum risk exposure would be 10% of your equity. 2% risk per trade and 10% maximum risk exposure is the standard and should keep most folks safe while trading.
• Position Size
  You could rename money management to position sizing as that is what's really all about. I'm using it here to describe how much volume to trade. In MT4 terms, we are talking about lots.
• Equity
  This is the available money to trade with according to the equity model that you've chosen to use (see above post on equity models).

I love this topic and really so should you. This really should be the first thing that any trader studies is money management.

__________________
-David T-
Verbtheory Trading Journal
-----------------------------------------------
When time is short, timing is everything.
In such an environment, technical analysis comes into it's own.

It's taking forever for me to finish! Been busy so busy sorry.

Now that we've talked about terminology that we'll be using. Let's discuss the different methods for "position sizing".

1. Manual
   This is for overriding common sense and arbitrarily placing a manual entry of position size such as 1.0, 20.0, 50.0 lots, etc…
2. Fixed Units Multiple (units per fixed amount of money)
   Position size = (Equity / Fixed Equity Multiple; Rounded Down) * Manual Lots (the # of lots you want to trade per x amount of capital)
3. Percent of Margin
   Position size = (Available Margin * Max Risk Exposure) * Risk per Trade
4. Percent Volatility
   Position size = ((Equity * Max Risk Exposure) * Risk per Trade)) / ((VOL * VOL X) * Symbol Point Value))
   This a volatility based position sizing, reducing your risk when volatility is high and increasing when it's more steady.
5. Percent Risk
   Position size = (Equity * Max Risk Exposure) * Risk per Trade (%...like 2% is normal)

The above represent 5 methods of sizing your position. Combine this with your chosen equity model and you now have a money management strategy that you can use in your trading.

At this pace, the 3/3 of post will happen in 2 months lol. Seriously I'll try to get to it this weekend. I will be putting it all together.

So we will have an example of equity model, position sizing and strategy results comparison so you can see how simply changing your money management strategy can improve your trading dramatically.

Ciao!

__________________
-David T-
Verbtheory Trading Journal
-----------------------------------------------
When time is short, timing is everything.
In such an environment, technical analysis comes into it's own.