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Advice on risk management

  • #1
  • First Post: Dec 26, 2007 11:40am Dec 26, 2007 11:40am
Hello Friends!!

I have been struggling with risk management aspect of my trading. Per my RM rules, I don't want to risk more than 5% equity on a single trade. Now, my Trading System might give me entry signals on two different currency pairs. If I take both the positions, I might end up taking a 10% exposure if the pairs are perfectly correlated.

On the other hand, if I take only one position, I will not have used my 200:1 leverage well.

Any thoughts?
  • #2
  • Dec 26, 2007 12:00pm Dec 26, 2007 12:00pm
The pairs traded doesn't matter... although I'd recommend no more than 3 to start.

The more intimate you are with a pair the better you'll be able to trade it.

Trade smaller lots... micro lots.

The great thing about the PIP is it can be any dollar value.
  • #3
  • Dec 26, 2007 12:47pm Dec 26, 2007 12:47pm
Your rules say 5% per trade. So follow your rules. Do you have a rule concerning how close of a correlation a pair must exhibit before they are considered one pair? -
Also, what do u mean by " not using 200:1 leverage well"?


Quoting Eklavya
Hello Friends!!

I have been struggling with risk management aspect of my trading. Per my RM rules, I don't want to risk more than 5% equity on a single trade. Now, my Trading System might give me entry signals on two different currency pairs. If I take both the positions, I might end up taking a 10% exposure if the pairs are perfectly correlated.

On the other hand, if I take only one position, I will not have used my 200:1 leverage well.

Any thoughts?
In trading, there is no bullshit. You either make money or you don't.
  • #4
  • Dec 26, 2007 1:46pm Dec 26, 2007 1:46pm
Quoting mrgreen
Your rules say 5% per trade. So follow your rules. Do you have a rule concerning how close of a correlation a pair must exhibit before they are considered one pair? -
Also, what do u mean by " not using 200:1 leverage well"?
I am not sure how to use correlation appropriately here. For example correlation between USD/JPY and EUR/USD is

EUR/USD 1 week 1 month 3 months 6 months 1year 2years
USD/JPY ....0.11 ....-0.93 .....-0.94 .......-0.77 ......-0.77 .-0.18
Per this table, 1 week and 2 year correlation is almost zero but for 1 month and 3 month they are almost perfectly negatively correlated.

How to interpret this table and make trading decisions so as to manage exposure appropriately?
  • #5
  • Dec 26, 2007 2:15pm Dec 26, 2007 2:15pm
Have you searched investopedia? Search currency correlations there. They have a good explanation of how to apply the tables and their different time frames. Hope this helps.
  • #6
  • Dec 26, 2007 2:22pm Dec 26, 2007 2:22pm
Quoting Eklavya
Hello Friends!!

I have been struggling with risk management aspect of my trading. Per my RM rules, I don't want to risk more than 5% equity on a single trade. Now, my Trading System might give me entry signals on two different currency pairs. If I take both the positions, I might end up taking a 10% exposure if the pairs are perfectly correlated.

On the other hand, if I take only one position, I will not have used my 200:1 leverage well.

Any thoughts?
Here's a good site for correlation tables. You are wise to be concerned about correlations. You should select the correlation time frame that most closely matches the time frame you expect to hold the pair. For example, if you expect to hold for a few hours then use the hourly correlation. The yearly won't matter much to you.

If you want to avoid correlation issues stop watching correlated pairs. There are plenty of uncorrelated crosses to trade.

Unless your system has an accuracy in excess of 80% I would suggest that risking 5% is WAY too much. Chances are you should be in the 2-3% range.

I have no idea what you mean by using your leverage. In general leverage is way overrated. If you risk no more than 10% of your account at any one time leverage will never be a concern to you.
  • #7
  • Dec 26, 2007 2:37pm Dec 26, 2007 2:37pm
Thanks for your reply philmcgrew!!

When I say leverage, I mean how much of my equity I am using in my trades. For example, if my equity is USD then with a 200:1 leverage, I have access to USD 100,000. If I enter a trade with a SL of 20 pips, using position sizing, I size my position such that 20 pips adverse movement will be a USD 25 loss to me(5% of 500).

Now, when I am in only one trade, I am using up only USD25 of my equity. The balance USD475 is lying unused that could be used profitably in other trades, provided I diversify the trades such that I am entering two distinct trades.
  • #8
  • Dec 26, 2007 2:47pm Dec 26, 2007 2:47pm
Quoting Eklavya
Thanks for your reply philmcgrew!!

When I say leverage, I mean how much of my equity I am using in my trades. For example, if my equity is USD then with a 200:1 leverage, I have access to USD 100,000. If I enter a trade with a SL of 20 pips, using position sizing, I size my position such that 20 pips adverse movement will be a USD 25 loss to me(5% of 500).

Now, when I am in only one trade, I am using up only USD25 of my equity. The balance USD475 is lying unused that could be used profitably in other trades, provided I diversify the trades such that I am entering two distinct trades.
Using your example, even if you are in 2 trades your broker has only set aside a total of $50 in margin ($25 each). You still have $450 in your account that you're not using. If your broker set aside $100 you would still have $400 in your account. You are still 100s of pips from a margin call.

Provided that you use a stop loss your margin is still a mere fraction of your account that your trading plan didn't permit you to use any way. You could trade at 20:1 and be just as successful. Make sense?
  • #9
  • Last Post: Dec 26, 2007 2:54pm Dec 26, 2007 2:54pm
Quoting philmcgrew
Using your example, even if you are in 2 trades your broker has only set aside a total of $50 in margin ($25 each). You still have $450 in your account that you're not using. If your broker set aside $100 you would still have $400 in your account. You are still 100s of pips from a margin call.

Provided that you use a stop loss your margin is still a mere fraction of your account that your trading plan didn't permit you to use any way. You could trade at 20:1 and be just as successful. Make sense?
Exactly!! I don't want to enter multiple trades if all of them are have common movements as in effect I am just multiplying my risk and not trading two distinct entry signals as they are related.
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