Money Management / Position Sizing

Hello. I'm still in the demo process but before I go live, I want to make sure I have my money management down pat. So far it's been fine but I need to be 100% confidently sure.

My trading style is to buy/sell a position and look to take 20 pips. However, if the trade goes against me, I'll take a second position in the same direction, 20 pips behind that. By averaging the two positions, I should be able get out earlier when it rebounds.

My risk/reward is 1-to-1. My total risk per trade is 1.5%. So for example, I sell the AUDUSD for .8020 with a TP at .8000 for .5% position. If it goes to .8040, I'll take a second .5% position with a SL of .8060. The first position will also have a SL of .8060. If it reaches .8060, I'm out 1.5%.

1) If I have to take a second position, I've put 1.5% at risk. So my TP should be for 1.5%. In this case, I should seek TP at .8000. Is this correct? This has me baffled because if I'm averaging positions, I thought I should be able to get out earlier.

2) If however, my first position went directly to .8000, I'd take my 20 pips. However, that is a .5% return on trade. Of course I should be happy, but it seems strange that this more "successful" trade returned less than the 1.5% one.

Please help me understand the logic of this MM. Or please offer any other forms that work for you.

Much appreciated!

Hello and welcome to the crazy world we call currency trading. Be aware that I am live since December 2007 (never demoed) and speak from alot of painful but learning experiences, a learning process that will continue forever (but not so painful anymore).

First off, there is a tremendously important aspect to trading you have not been exposed to yet doing demo....emotions. When you start trading live, knowing that you can either make or lose money messes with your psychology big time! You go from hyper mode to impatient mode in an instant (if you start pacing around your room for example..its normal), as you see each pip move for or against you (it takes ALOT of time to learn to control your emotions, I still struggle with revenge trading once in a while). For this reason I HIGHLY recommend you do not commit more then possibly 10 cents per trade until you have gained enough experience in the markets to get into the "comfort zone". This process may take a month or a year, it entirely depends on you.

Secondly, we are all unique individuals....our personalities so diverse that in most cases what may work for me or another will not work for you. For example, a trader who has alot of experience in the markets may have reached the point where they are comfortable with a 100pip stop loss and 200pip take profit while another trader of equal experience may have a 20pip stop loss and 20pip take profit. This entirely relies on comfort levels to market exposure from how long any given individual is willing to stick with a trade (1min to 1month or longer) and how much they are willing to risk per trade (most profitable traders go in between 1%-3% risk per trade with others as high as 5%). Nevertheless, regarding your strategy, it entirely rests upon your shoulders to find out what your comfort zone is (now you understand better why I said 10cent trades when you first start live).

Thirdly, your stop loss/take profit ratio depends big time on how you trade.

-Tight stops and take profits rely heavily on a very mechanical strategy. This in turn relies on having some powerful indicators that you have mastered in interpreting and using. While most new traders start trading by scalping, this is the main reason they blow their accounts, lack of experience and understanding what they are doing. Very few individuals can trade by scalping and usually they have alot of experience in the markets as well as impeccable strategies based on indicators (Cobraforex to name one).
-Those who employ a larger stop loss/take profit ratio are not so mechanical as they are psychological, they try to understand the markets from a panoramic perspective...a birds eye view first and things such as fundamentals come into play. This is the preffered method of trading by most successful individuals that you may or may not hear about. For example (which is what I tend to do), I may look at a particular pair and determine levels of interest (strong Support or Resistance on a daily scale) then gradually move in to the time frames that I trade to pinpoint those S/R levels even better. At that point in time I also check out whatever fundies are scheduled for the day or even the week and place trades according to my strategy.

Fourth, no one pair is the same! While the Eur/Usd may have a daily range of 100-200pips....a pair such as Eur/Jpy (which I currently trade) may have a daily range of 300pips +. This is very important to know if you do plan to test out your strategy, as you require a pair that is relatively volatile, but not so volatile that you will get stopped out in an instant (I guarantee you that 20pip stop loss will never be enough on a pair such as Eur/Jpy).

Fifth, timing! You may hear all the time, a successful trader is a patient trader. That is so very true but why is it true? It depends on strategy really. For example a long term trader may show patience just sticking with a trade they placed a month ago. A swing trader that may hold a trade for a few days or few weeks may show patience by picking a swing high or a swing low as entry point. A scalper as you want to be is patient by waiting for the right timeframe to trade. You are most likely to be successful with that strategy when the markets are ranging, you want to avoid news releases as that will create alot of volatility, overlapping Eur/US stock market sessions as that too creates unstable conditions and focus only on the timeframes that are relatively inactive (which is why #4 is so important). Those inactive timeframes are usually the period between the US stock market close and European market open or better said..the Asian session.

I think that about covers it, there may be details I forgot to mention but this alone should get you started on the right track. Remember, when first going live, start small to learn to control your emotions and figure out your stop loss/take profit ratio (profits come later...in most cases much later).

Good pippin in your future

My trading style is to buy/sell a position and look to take 20 pips. However, if the trade goes against me, I'll take a second position in the same direction, 20 pips behind that. By averaging the two positions, I should be able get out earlier when it rebounds.

My risk/reward is 1-to-1. My total risk per trade is 1.5%. So for example, I sell the AUDUSD for .8020 with a TP at .8000 for .5% position. If it goes to .8040, I'll take a second .5% position with a SL of .8060. The first position will also have a SL of .8060. If it reaches .8060, I'm out 1.5%.

When you open your trade (in the example you gave) do you initially have your stop on the first piece at .8060 (40 pip stop with a 20 pip target)? This makes your 1:1 risk to reward a little tricky to define. I know you intend to add on at -20 pips, but...

1) If I have to take a second position, I've put 1.5% at risk. So my TP should be for 1.5%. In this case, I should seek TP at .8000. Is this correct? This has me baffled because if I'm averaging positions, I thought I should be able to get out earlier.

No, you can't get out at 1.5% profit any earlier. You will get back to B/E earlier with two positions open, if it goes in your favor. When you open your second position, your first position is already -20 pips. With your new "doubled" position, you only need price to move back in your favor by 10 pips to get to B/E.

Let's use $1 per pip for each position to keep it simple. By opening the new additional position, you have a higher average entry price. You were -20$ when you opened the new position at .8040. Your new position is now worth 2$ per pip. You now have $60 at risk.

The average price of your new larger position will be .8030 (one sold at .8040 and one at .8020.) So a 10 pip move in your favor (10 pips X $2 = $20) from your second entry (.8040 to .8030) will have you at break even .
To maintain your 1:1 risk to reward, you need to make $60. Your average entry is .8030, so you still need to get to .8000 to get $60 profit.

2) If however, my first position went directly to .8000, I'd take my 20 pips. However, that is a .5% return on trade. Of course I should be happy, but it seems strange that this more "successful" trade returned less than the 1.5% one.

You didn't risk as much as you did in the 1.5% trade.

I would have to have a very good reason to average down. I wouldn't do it as a regular strategy. You're making a habit of adding to trades that are moving against you. I'd rather add on to trades moving in the right direction.

Thanks for the message psiholog! Those are wise words of advice I am doing my best to adheed to. Surely there will be a steep learning curve when trading live. I hear some people saying that trading demo is a waste of time and that the only useful learning can be done by going live.

It would clearly be in my best interests to reduce my trading risks to as low as possible when first starting out. And then slowly building up from there. Though my initial bankroll will not be high, the point shouldn't be to try to increase it as soon as possible. As I see it, if I can show consistent profit in the first few months to a year, that will demonstrate fx as a viable possibility.

There seems to be as many systems out there as there are traders. I keep hearing that it isn't difficult to find a trading system that works. But it is difficult to stick to it consistently and limit risks, instead of searching for the better combination of indicators that will lead to the holy grail.

Patience is the greatest virtue. FX is not gambling and losses should be limited whenever possible.

Thanks again for the great advice! Happy trading to you!

You are right, billflet! Now it makes sense to me. I think that the point of taking the second position would be best used to get a better combined average, and then get out at BE. If indeed it is a good idea to begin with, which you were dubious about. I hear you there.

IF my risk/reward is 1-1, then I just need a slightly better than 50% win rate to come out ahead. Just like the houses do in vegas. In that case, there is no need for a second position.

The only other case where taking a second position might be worthwhile, is if r/r is 2-1 or 3-1.

I am also interested in learning more about building up positions for longer-term trades, ones where prices move 200-300 pips. But that might be for another day. Thanks again for the great info billflet!

Many get caught in the psychological trap of not wanting to take a small loss and so average down and soon end up taking a huge loss. If greed or hope are playing any part of your decision to do this then you are wrong - just get out.
The idea of taking on a 2nd position in this situation is very tricky. You must be fairly certain that you are not on the wrong side of the market and that your timing was simply off. The first scenario could be a disaster, the 2nd can be profitable. Again it is a tricky thing and should be an item you may wish to explore after you have some experience and understand the pair you are trading. Experience I define as at least 2 - 3 years trading a live acct. Discipline yourself first and learn how you react to greed and hope.

Exactly.


By MagicTrader:
1) "If I have to take a second position, I've put 1.5% at risk. So my TP should be for 1.5%. In this case, I should seek TP at .8000. Is this correct? This has me baffled because if I'm averaging positions, I thought I should be able to get out earlier."

You should never "have to" take a second position on a losing trade. Like MrGreen pointed out, if you are convinced you missed your entry by 20 pips it's one thing.
However if you're looking for a 20 pip target and the trade has already gone 20 pips against you, that 's more than a misplaced entry. It simply means the trade didn't work and it's time to exit quickly.

You might know that I have a slightly different view on this.

1st: Every trade is a losing trade in the beginning.

There is nothing wrong to add to a position (in both ways!) as long as you keep an eye on your risk. Cost averaging is a very powerful thing if applied correctly.

RISK = STOP LOSS * POSITION SIZE. Most say risk no more than 2%. That will work. If you start with $1,000 that's $20 per trade.

Your trades aren't losing. They're developing.

he is playing word tricks meaning you pay a spread fee so it's losing initially.

if using position = acc size possibly averaging at max 1 time is a working strategy.

in monthly income deposit to stock index type of stategy, actually a person does 12 times averaging per year. w/o adding risk.

actually what he takes is a statistical average, if you assume over the long term the index is a white noise, then at some point averge=statistical median and if price run to 2 sigma you can get a nice profit.

I know what he means.

When I initially enter trades, I feel quite confident about my targets. And when taking second positions, more often than not prices return to BE and then to profit, actually. However I'm not sure the stress is worth it.

It'd probably be smarter to wait for better trade opportunities. In such cases risk/reward could be higher than 1-1. And so there'd be no need for second positions. If trades stopped out, so be it.

Thanks for all the helping words, everyone. All the lessons I've been learning on FF have hopefully shaved months and years off my learning curve.

Lol, yes you're right both billye and billflet. Are you siblings?

You found us out. billye is my identical twin brother. From a different mother. And a few years younger.

And BTW, he was always the favorite.

Xaron, can I ask how you apply your cost averaging?

Yes.

I'm sorry, couldn't resist.

Applying cost averaging is simple. It's much more difficult to see when one is wrong. Always keep an eye on the overall position size and never close everything for a loss but scale out by closing the "most out of the money" positions.