A trader\'s money management system

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c10 JWBK182-McDowell April 25, 2008 16:11 Printer: Yet to come

84 A TRADER’S MONEY MANAGEMENT SYSTEM

favor, and it is not all that hard to do. The first priority is to correctly iden-

tify what needs to be adjusted, so you know where to focus your energy.

Three very important formulas enable you to control risk:

1.2 percent risk formula

2.Trade size formula

3.Trade size formula using leverage

TWO PERCENT RISK FORMULA

As a starting point, I recommend that you do not risk more than 2 per-

cent on any one individual trade. If you are a more advanced trader and

choose to risk more than 2 percent, you will want to substitute the 2 per-

cent amount in this formula with the percent you decide to have at risk

prior to doing this calculation.

Formula:Account size×2%=Risk amount

Example:$25,000×2%=$500

Remember, the risk amount of $500 includes commission and slippage,

so as you will see in the following trade size example, you will need to take

that into account. Now that you know what amount you will risk on your

trade ($500) you can figure out your proper trade size.

IMPORTANT NOTE: For some advanced traders, it is beneficial to

risk more than 2 percent of their trading account. The amount these

traders risk must be carefully calculated depending on their proven

historical performance statistics. See Chapter 9 for the formulas to

determine if your payoff ratio and win ratio performance warrant a

higher risk than 2 percent.

TRADE SIZE FORMULA

In our example, we can risk $500 on a $25,000 trading account. The formula

for determining proper trade size for this risk amount is as follows:

Formula: [Risk amount−Commission]

÷Difference between entry and exit=Trade size

Example:[$500−$80]÷$1. 50 =280 shares