Risk Management vs Proper Capitalization

After years of studying the markets and designing system after system, I have finally found something that works for me. I took it live these last two weeks and was very disappointed with the results. A member of my trading group also used the same method, (it is automated) and made 4 weeks worth of goal during the same time period.

What causes this vast disparity in results? My conclusion is that I stuck to some very rigid risk management rules, and "locked in" losses while my friend continued trading and made money.

My risk management rules are based on percentage of capitalization but it after these last couple of weeks it appears they were too tight...

So here is what I did...each trade enty risks 2%. I stop trading if I reach 3% loss in any day, and 6% loss in any month.

Well, looks like I'm not trading for the rest of the month...but I'm wondering, do any of you LIVE traders out there have any suggestions for capitalization and risk managment?

I'm thinking of recapitalizing but this time sufficient for each trade to risk 1%. Do you think this too much risk?

Most books I've read use the standard 2%, 6% rules...but those are books...what are you LIVE traders doing out there?

Hi,

I think to properly answer your question, you have to ask yourself how much would you are ready to lose? It doesn't matter how many percentage would you risk (for now), as long as you are ready to accept the percentage of losses that you have decide. There are great difference between accepting losses/risk and to know how much you risk.

I use around 5-10% risk from my capital each month. From that, I would divide the percentage into how many trades that I'm going to take. If the trades are profitable, perhaps I can use the profit to risk more. Just make it simple.

Another thing is, keep on practicing your system. I mean, if you use it like 2-3 months and still not gaining any profit. Keep on practicing, you'll lose your money but you gain experience with the system. Once you are good with the system, the profit will come to you. As long as the system has an edge, and with proper money management, you are good.

Just my 2 cents.

Good Trading!

Why would you stop trading if you lose any x% of capital on any given x time? Each and every trade is different... why a certain capital loss in previous one or few trades has to do with the next one?

Unless one is addicted to trading, such primitive rules are just useless.

I've come to agree with this statement. "Fixed loss percent per day, then quit" rules apply better to manual trading than automated. These type of rules protect the discretionary trader from chasing his losses and getting emotionally involved.

You really need to know the expectancy of your method and how many consecutive losses you might incur over a period of time. Then adjust your position size to where you won't be emotionally destroyed if you have x number of losses. Decide what amount of drawdown it would take to convince you that your method is broken. If you reach that point, then stop and re-evaluate.

If you are risking 2 per cent per trade and shutting down after a 3% daily drawdown, you're not giving your method much room. You should probably adjust your position size. If your first trade loses and your second only goes halfway to your S/L, you're down 3% and out for the day while your trading partner is still doing battle.

Traders,

I appreciate your taking the time to respond to this thread. There were several questions that came up on your posts so I feel I should address each. If nothing else this may help me to understand my risk policy.

How much risk am I willing to accept? There is only one NON negotialble fiigure in this policy and that is 6% per month. What I did was to divide that figure up into a daily amount based on my position size and stop loss. I feel it imperative to stop trading if I loose more than this percentage in one month. This preserves the bulk of my capital for the following month if the entry system has a bad month. As we all know no matter how accurate your method of entry, sometimes the market just doesn't agree.

Why stop trading if I lose x% per day? Clearly this was a mistake. I was sizing my positions to 2% risk each and didn't think this would be a problem, but I now agrees this was a mistake.

I am going to recapitalize again but was wondering what you LIVE traders thought as far as position sizing. 0.5%, 1%, 2%? I know this seems a stupid question but here is my reasoning at this point.

My method of trading is very limited (again to maintain a high level of accuracy). I only trade during optimal hours, I only allow three entries in any given 24 hours, and if I have a winner I stop trading, or if I have three losers, I stop trading. Normally the losers are small enough that if winner comes along it will negate the losers and show a profit.

However, I must accept the fact that all three entry COULD stop out. While the probability of this is low it is NOT zero. So If each position is 1% of total capital, then I decrease the probability of reaching the fatal 6% cut off...does this make sense?

For me this would require a 30-40K account capitalization to trade a single 3 mini lot position. (3 minis because I take profit at 3 different points in each trade)

Am I just spouting garbage or does this plan make sense to any of you?

I think the problem is with the 3 consecutive losses and you stop trading. I think your MM is good enough as long as you know how much you are risking. But when you decide you going to stop trading after 3 consecutive losses you stop, who knows that the forth trade will cover your losses but since you stop. You out with losses. For me as long as the signal from your system come out, enter it with considerable risk that you have assign to it.

Few weeks ago, Im down with around -14%, but if I stop trading, I would not be able to cover the losses. Now, Im up more than 20%. During my early trading days, I always stop when I got more than 4 consecutive losses. And after that, the market trends and Im not in. Hope it helps. And dont be confused with overtrading.

Arcus,

I agree with what you say. I guess I'm not explaining myself very well. The reason for three trades in any given 24 hours is that from my back testing and forward testing I found that usually when the market is oscillating in a very narrow range, my system will generate numerous "false" entry signals. As so often happens these signals can quickly bring down my account balance.

These signals tend to happen during the hours when there is no or very little activity, which is why I limit the time the EA will trade. But also when the market is consolidating, during "normal" trading hours, the system will generate entry signals when the market really hasn't made up its mind.

Like you say, we can never know which one will be the signal the eventually produces the good win, but I've found that if it gives me three or more losers during the "normal" trading window, then it will probably continue to do so and I can't think of any reason to continue generating more risk until the market has made up its mind.

If the "break out" occurs while I'm not trading...there will be other opportunities the following day or week, but to allow an automated trading method to continue to generate loss after loss does not make sense to me. Thus I have programed some (what I consider) reasonable limits.

I am willing to accept my losses as being part of what it takes to win but I also think that limiting my exposure is also prudent. when you have a "bot" trading for you most of the time you have to tell it when NOT to trade or it will pound you into the ground no matter how good the entry signal is.