Hi I'm Luke from Disciplined Trader and in this video I want to discuss the factors that
will help you decide How Much you Should Risk Per Trade
In the last video we looked at the factors that help determine how much money you may
make from your trading.
One of those factors was your risk appetite, in other words how much of your account you
are willing to risk on a particular trade.
If you haven't seen that video yet, I will leave a link to it in the description below.
So in this video I want to carry on with this topic and try to help you decide how much
of your account you should risk.
As stated in the disclaimer at the start of this video, this is only my opinion.
This is does not constitute investment advice and is for educational purposes only.
The first thing you need to decide is how much you actually feel comfortable losing
in one trade.
What I mean here is that you should decide what amount you could lose on one trade and
not be mentally effected by that result in such a way that it causes you to lose your
discipline.
You should be able to continue to objectively assess the market for further opportunities
without falling into the trap of emotional trading.
Let�s look at an example - if you�re trading with a �5000 account and you lose �1000
on one trade, that's likely to affect you mentally.
Then you start thinking "that's 20% of my account gone, I�ve got to make that back!
And quickly!".
You might then start deviating from your trading plan and force trades that don't meet your
strategy criteria because you want to make the loss back, when in actual fact you just
end up with further losses.
Obviously that's not something you want to be doing so putting rules in place to stop
you getting to that point can be a huge help.
You may decide that �100 or �200 of your �5000 account is an acceptable loss per
trade and that if that was to happen you would still be able to identify correct set ups
and implement your trading plan properly.
Fantastic!
you now have rules in place that stop you becoming an emotional trader and allow you
to analyse the market objectively.
The next thing to consider is the win rate of your strategy.
Different strategies have different win rates and different risk to reward profiles.
One strategy may have a low win rate but a high risk to reward ratio whereas another
could have a high win rate and a lower risk to reward profile and both can be profitable.
The reason for analysing this is it is good to know how probable a losing streak could
be and again you need to be mentally comfortable with this so it plays an important role in
determining how much to risk per trade.
Let�s look at an example
Let�s say we have an account of �5000 Our strategy has a win rate of 50% and a risk
to reward profile of 2:1 We know the strategy is profitable as, on
average, in every two trades one is a winner and one is a loser.
When it loses it loses 1 and when it wins it makes 2.
That means, on average, after every two trades the strategy returns 1 profit.
1 been equal to whatever lot size or pound per point value you are trading at.
However, the distribution of winning trades and losing trades is never as simple as win
lose win lose win lose.
If it were, dealing with the psychology of trading would be a much easier task!
No the distribution of winning trades and losing trades is completely random and unknown.
Although in the long run will equate to a 50% win rate.
That�s what's important to remember.
A major mistake I used to make was throwing good strategies away simply because they went
through a short term losing period - i'd lose confidence in the strategy before benefiting
from the long term profits.
If you have back tested a strategy over a good sample size and know the probabilities
of short term losing streaks, this should give you the mental confidence to achieve
the results the strategy is capable of if implemented correctly.
So it's good to know how likely a losing streak could be.
Let�s look at how to work this out
First we work out the probability that a trade loses.
So we do 1 - 0.5 (win rate) = 0.5 So the probability of a losing trade on any given trade with
this strategy is 50%.
(I�m sure you recognized that straight away anyway!)
Now we know the probability of a loss on any given trade we can calculate how likely two
losing trades are in a row.
We simply multiply the chance of the first trade losing by the chance of the next trade
losing.
So it will be
0.5 X 0.5 = 0.25 so this strategy has a 25% chance of having tow losing trades in a row.
We can now take it a step further and calculate the chance of 3, 4, 5 and 6 losing trades
in a row
As we can see the probability of three losing trades in a row is 12.5%, 4 losing trades
in a row is 6.25%, 5 losing trades in a row is 3.125% and six losing trades in a row is
1.5625%.
Now a 1.5625% chance of something happening is pretty low but it could still happen and
now you can prepare yourself for it.
You can ask yourself the question, if I suffer six losing trades in a row, how much could
I lose and still keep my discipline?
If you were risking 10% per trade then after six losing trades you would be down 60%.
Now even if you could cope with that from an emotional point of view, that's going to
be really difficult to trade back from.
You may decide that you don't want to have a draw down bigger than 10% on a losing streak.
Which would mean that 2% risked on each trade would be slightly too much as this would equal
a 12% draw down on a six trade losing streak but 1.5% or 1% would be okay as this would
result in a 9% or 6% draw down only.
Enabling you to keep your composure and discipline in order to trade through the short term losing
streak.
Knowing this information then mentally prepares you for when you take a few losses in a row.
You're no longer worried or questioning your strategy because you know in actual fact the
likelihood of having a losing streak is fairly probable and you simply need to maintain your
discipline and trade through it to reap the rewards your strategy has to offer.
Now
this may be a slightly simplistic view of how your trading may pan out.
This may because you trade multiple strategies or take day trades and swing trades and the
win rates of all these different strategies and approaches may vary.
However, if you view the different strategies in isolation then you can work out the probability
of losing streaks for each strategy individually and knowing the probabilities behind your
strategy enables you to stay objective in your approach to the markets and helps prevent
any emotional trading taking over.
Your number one goal in my opinion as a trader should be the preservation of your capital
and that's why deciding how much you risk per trade is such an important decision.
And a personal decision too.
You need to consider the actual technical information about your strategy and approach
and make sure the amount you decide to risk doesn't actually put your account in danger
of been wiped out by a streak of losing trades.
And you need to consider how you will deal with a loss or losses for whatever amount
you decide to risk.
If you think it will hinder you mentally, then risk a smaller amount and build up to
larger risk slowly if you feel you need to.
So finishes off that topic nicely.
In my next video I will show you how to calculate the potential returns from your own strategy.
Whatever it may be
Thank you very much for watching.
I hope you found this video useful.
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You can also visit the Disciplined Trader blog where I write various trading related
articles.
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pages.
Thanks again for watching and I hope you all have a good trading day!