40. Money Management: How To Determine Initial Stop Levels

http://www.informedtrades.com/

A less on how traders determine their initial stop levels when trading the stock, futures, and forex markets.

In our last lesson we looked at the difficulty of overcoming a loss in the market to further emphasize the importance of protecting your trading capital as a critical component of any successful trading strategy. In today's lesson we are going to start to look at the first and one of the best ways of protecting one's trading capital, setting your initial stop.

As we learned about in our lesson on the effects of trading losses, 50% or more of the trades made by many successful trading strategies are losers. These trading strategies and traders are successful not because they are highly accurate on a trade by trade basis, but because when they are wrong they cut their losses quickly and when they are right they let their profits run. While the trading strategy that you eventually end up trading for yourself may have a higher success rate than what I mention above, any strategy is going to have loosing trades, so the first key to staying in the game is to have a plan for managing those losses so they do not get out of control and wipe out your chances for success.

With this in mind, what most traders will start with when designing a plan for setting their initial stop loss is the amount they can afford to loose on a per trade basis without having a detrimental affect on their account. While this varies from trader to trader and from strategy to strategy, as Dr. Alexander Elder mentions in his book Trading for a Living, many studies have shown that strategies and traders who risk more than 2% of their overall trading capital on any one trade are rarely successful over the long term. From what I have seen most traders risk way more than this on an individual trade basis, another large contributor to the high failure rate among traders.

Traders who set their per trade risk level at 2% of their trading capital or less, not only put themselves in a situation where a fairly lengthy string of losses will not knock them out of the game, but also put themselves in a situation where any one trade is not going to make or break their account. This is important not only from a money management standpoint but also from a psychological standpoint in that they are not attached to any one trade and are therefore more likely to stick to their strategy.

In order to have a true understanding of what this number should be for a specific strategy you will need to know what the expected accuracy rate is for the strategy, something which will cover in later lessons. For now however it is sufficient to simply understand that you need to have a feel for how much you plan to risk on a per trade basis as a first step in designing a successful money management strategy, and that you should be very wary of any strategy which risks more than 2% of your trading capital on any one trade.

Now that we understand that determining how much to risk per trade is the first step in any successful money management strategy, we can move on to other methods of setting your initial stop which fit within the limit set by the amount a trader is willing to risk on a per trade basis.

As always if you have any questions or comments please leave them in the comments section below so we can all learn to trade together, and good luck with your trading!

Category:

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[dalesalsa]

these videos are great but I wish they were longer. We can talk about money management and position sizing and stop levels a lot lot more.

I think Dr. Van Tharp has an entire book on Position Sizing and although I have not read it- It is probably excellent.

[InformedTrades]

Yes I have not read Van Tharp's position sizing book either but his book Trade Your Way to Financial Freedom is one of my favorites. Best Regards, Dave

[kwmcglon]

i love these vids!!!!!!!!!!!

[InformedTrades]

Hi kwmcglon, Thanks for the comment I am happy you like the videos. Best Regards, Dave

[ajascent]

this an amazin video keep it up.

[InformedTrades]

much appreciated. Thanks for the comment. Best Regards, Dave

[joshuademoraes]

a game??? don't you think it's better to get road to Las Vegas and play poker? at least drinking is for free :D :D

[TheEngineer1371]

Great video! I recommend using this iPhone app called Forex Trader Money Manager. Check out my channel here on youtube for a short demo. Wishing all the best trades!

[Mauricio7344]

great video. by the way as i have full time job, is it possible to trade in 4hrs time frame using 0.01 lot size in many pairs with a 3k account? i have a good strategy that i could use in short time frames, but beause i ave a full time job that is why i amtryng to go to 4hrs time frame. at same time i dont want to get 100years old and i am still poor.ahahahah

[edwardwills]

How do you bet 2% if all you have is 10K?

[bearwoodbrown]

I think this is a very important figure and it makes sence 2 percent and like you say if you can do again and again

[FreeFOREXautoROBOT]

100% Free Forex EA - works perfectly fine for me.

[miasma1616]

@nativepangea

Commissions? even at discount broker levels, thats 5% you have to gain on your 200 just to break even...

[rbonilla18]

I risk 1% per trade and I get 0.5% ~ 2.5% gain per day after loses.

[joshuademoraes]

yes ...and remember your max risk in your portfolio...If I lost 20 % of portfolio I quit my trader's life....

[metsfan259]

I think this means when that your stop is placed at a position where you can not lose more than $200 . That is the only way to follow this 2% rule with a 10k portfolio.