Like the entry&exit process of this trading system, the money management will be easy to apply. Even it could appear really simple, it relies on sophisticated and efficient observations.
In few words, the money management of this system uses constant risk approach. We risk for each trade 2% of our account. That’s all.
The technical trading is just a game of probabilities. If you want to have the odds in your favor, you have to respect the rules of this game by trading with constant risk. If you use dynamic risk (changing your risk depending on your trade), you change the expectancy dynamically. That’s a bad idea.
For each trade you take on the market, you have a related expectancy (Trading is just probabilities…). It can be calculated with this formula :
Expectancy = Winratio x Average Gain – Lossratio x Average Loss
- Winratio : the percentage of winning trades of your system at the end of the year
- Average Gain : the average profit you make when your position is successful
- Lossratio : the percentage of losing trades of your system at the end of the year
- Average Loss : the average loss you make when your position is unsuccessful
It’s easy to see that if you change the risk taken on each trade, your Average Loss will change accordingly. This makes the expectancy varying depending of which trade you take. In other words, the profitability of your system is changing and varying each time you take a trade. It’s a moving expectancy.
If you want to be able to evaluate the viability of your trading system you have to set the values. It’s hard to assess a system with losses changing all the time. You have to set your Average Loss value with a static risk.
When you trade your system, the decisional basis is always the same. You enter the market relating to your discretionary system based on the same conditions. Why a trade would be more profitable or risky than another one when you don’t know if it will be a winner or a loser ?
There is no reason. You don’t know if a trade will be a loser or a winner. That’s why you have to treat each trade with the exact same risk.
If we have a system with a 75% winratio and a 25% lossratio, using a simple R:R of 1:1 and risking 2% on each trade for example, it makes :
Expectancy = 0.75 * 2% – 0.25 * 2% = 1%
Each trade you take has a chance of giving you 1% bonus on average. If now, you change the risk you take on the trade depending on your mood, you could win more but you could lose more too. Increasing the risk and seeing your trade being a loser one and decreasing it and seeing your trade being a winner one will make you lose money overall.
Hint: you never know if a trade will be a winner or a loser
Stabilize your expectancy by setting your risk value. Personally, I always risk 2% per trade.
To be concrete, you don’t have to care about the number of lots you use. It has to be calculated automatically depending of your stoploss distance. You can use online tool like this one or you can use Metatrader script like Easyorder. This last option is really helpful because you just have to enter the risk you want to take.