50. How to Set Trade Position Size for Maximum Profits

http://www.informedtrades.com/
A leIn yesterday's lesson we talked about the martingale and anti martingale methods of trading which are the two categories which position sizing methodologies fall into. In today's lesson we are going to talk about one of the most basic anti martingale strategies, which is discussed in Dr. Van K. Tharp's book Trade Your Way to Financial Freedom, the Percent Risk Model.

The first step in determining your position size using this method is to decide how much you are going to risk on each trade in terms of a percentage of your trading capital. As we have discussed in our previous lessons on setting stop losses, studies have proven that over the long term traders who risk more than 2% of their capital on any one trade normally are not successful over the long term. Another factor to consider here when setting this percentage are things such as the win rate (how many winning trades) your system is expected to have versus the number of losing trades as well as other components which we will discuss in future lessons.

Once this loss in percentage terms has been determined, setting your stop then becomes a function of knowing how large a position can be traded while still being below your maximum risk level.

As an example lets say you have $100,000 in trading capital and you have determined from analyzing your strategy that 2% or $2000 (2%*$100,000) of your trading capital is an appropriate amount to risk per trade. When analyzing the Crude Oil Futures market you spot an opportunity to sell crude at $90 a barrel at which point you feel there is a good chance it will trade down to at least $88 a barrel. You have also spotted a strong resistance point at just below $91 a barrel and feel that 91 is a good level to place your stop and also gives you a reward to risk ratio of 2 to 1.

From trading crude oil you know that a 1 cent or 1 point move in the market equals $10 per contract. So analyzing further to determine your position size you would multiply $10 times the number of points your stop is away from your entry price (in this case 100) and you would come up with $1000 in risk per contract. Lastly you divide the total dollar amount you are willing to risk by your total risk per contract ($2000 total risk/$1000 risk per contract) to get the number of contracts which you can place on this trade (in this case 2 contracts)

As Dr. Van K. Tharp Points out in his book Trade Your Way to Financial Freedom, the advantages of this style of position sizing are that it allows both large and small accounts to grow steadily and that it equalizes the performance in the portfolio by the actual risk. As he also points out the disadvantages of this system are that it will require you to reject some trades because they are too risky (ie you will not have enough money in your account to trade the minimum contract size while staying under your maximum risk level) and that there is no way to know for sure what the actual amount you are risking will be because of slippage which can result in dramatic differences in performance when trading larger positions or using tight stops.

That completes our lesson for today. In tommorow's lesson we will look at another position sizing model which is known as the Percent Volatility Method.
sson on the % Risk Model of setting position sizes for active traders of the forex, futures, and stock markets.

Category:

Howto & Style

Tags:

• howto
• trade
• trading
• position
• sizing
• daytrade
• investing
• money
• finance
• business
• forex
• futures
• stockmarket
• informedtrades

[sigamani1982]

How do you work out the reward/risk ratio?

[InformedTrades]

Hi Sigamani1982, Thank you for the comment. You do this by taking your profit target and dividing it by your stop loss level. So for example if you are targeting 100 points and risking 50 your reward to risk would be 100/50 or 2 to 1. Best Regards, Dave

[PLooBzor]

What do you mean by the term 'slippage'?

[InformedTrades]

Hi Ploobzor, Thanks for the comment. When you enter an order to buy or sell a financial instrument many times the order is executed at a price which is different from the price which you clicked on. This can happen for a number of reasons including there not being enough of the instrument at the price you wanted, internet delays etc. The difference in the price which you clicked to trade and the price where you are executed is referred to as slippage. Best Regards, Dave

[mathiasjlee]

Perfect, I read your explanation and it sure helps. Love your website as well, by the way.

Mathias

[InformedTrades]

Thanks again. Dave

[DayTradersWin]

Interesting video - friend and subscribe for day trading, day trader, day trade videos, technical analysis...

[abridgewater101]

Learn something!!! Be knowledgeable as you watch this video! Want more? take a look at my videos! :0

[ja1827]

I don't understand the idea of risk per contract, and I think it's because I'm not sure I understand how the term contract is used here. What does contract mean?

[FreeFOREXautoROBOT]

Got Free Forex EA - very profitable

[sp00nman8]

because the way charting techniques and the high minus the low, you CAN develop a way of finding (through volitility and ATR) exactily how much it will go up, verses where it is, where it was, and where it might go. Charting techniques is a valid way of doing that all for you, visually depicted for you. You should check out IBFX's PRS. It is a free program that you download that streams valid charting patterns (real time, from 15 min,to daily intervals) Every 15 min, average of 10 charts! BANG!

[davedaddy101]

I have no idea what the hell this guys talking about.

[mrjatu]

The attack sequence below were within 7 5min bars, and that is how short the battle lasted for one trading session last week. Usdjpy drop 100 pips, but on that trading session I banked more than 400 pips. One lot scout was still left in the battlefield to ride the trend down(without setting STOP off course). In my opinion "stops" are sitting ducks, it provide sweepzone for market makers.

[mrjatu]

Just to illustrade: S x USDJPY x 1 x 9998 scout in S x USDJPY x 3 x 9960 attack S x USDJPY x 5 x 9955 attack B x USDJPY x 5 x 9932 profit taking B x USDJPY x 3 x 9923 profit taking scout still in the battlefield S x USDJPY x 3 x 9960 attack S x USDJPY x 5 x 9951 attack S x USDJPY x 8 x 9940 attack B x USDJPY x 8 x 9931 profit taking B x USDJPY x 5 x 9923 profit taking B x USDJPY x 3 x 9915 profit taking scout still in the battlefield