Trading Systems and Money Management : A Guide to Trading and Profiting in Any Market

(やまだぃちぅ) #1
No serious trader should ever risk more than a few percent of his total capi-
tal per trade. Trading with such a high fas 20 percent will severely reduce your
staying power when you hit a streak of bad trades (and in this case you only need
three to reach a drawdown of 50 percent), which will unarguably happen at some
point.
There also are plenty of other ways to calculate an fthat is not based on the
worst historical loser. Personally, I prefer to substitute for the worst historical loser
whatever I am prepared to lose per share for that particular trade. This is easily
done by substituting the WCS with the stop-loss level for that particular trade and
for all trades and do all the calculations on a one-share basis. In this case, the
worst-case scenario will be based on what you’re willing to tolerate for this very
trade, instead of what you were willing to tolerate in the past while hoping that
experience won’t repeat itself.
For example, assume again we already found the optimal fto be 2 percent.
Suppose also that we are willing to risk $2 per share on a $100 stock and that the
trade ended with a profit per share of $5. Then, the HPR for that trade will be 1.05
[1 0.02 * (5 / 2)], or 5 percent of available equity going into the trade. Now, sup-
pose a second trade on a different stock, priced at $50 and with a stop loss of
$1.25, ends up with a profit of $2. Then the HPR for that trade will be 1.032 [1 
0.02 * (2 / 1.25)], or 3.2 percent of available equity going into the trade. The TWR
for these two trades will be 1.0836 (1.05 * 1.032), or 8.36 percent of the available
equity going into the trades.
It is also a good thing to substitute for the WCS an individual stop loss for
each trade because the stop loss is not a once-in-a-lifetime (hopefully) terrifying
experience, but a rather reasonable amount that you are prepared to encounter fre-
quently. This is good news, because if you take a look at the formula for the HPR
again, you will see that the smaller the WCS, the larger the factor Profitn/ WCS.
Thus, the fcan be lowered to produce the same HPR. In other words, the less we
are willing to risk per share traded, by lowering the value for the WCS to an
amount more suitable to each specific trade, the less we need to risk of account
equity to achieve the same HPR and, ultimately, TWR.
Using a variable stop loss while risking the same relative amount of your
capital for each trade, it still is simple to calculate the number of shares to trade
and the exact amount of capital needed for each trade. First, after figuring out the
percentage of capital you’re willing to risk, determine the stop loss for your next
trade. For example, if you go long at 100 and your stop loss is placed at 96, you
are willing to lose four points per share. Next, multiply your account balance
entering the trade with the fvalue you have decided on. For example, if your
account balance is $100,000 and your fis 0.02 (2 percent), you’re willing to lose
$2,000 per trade (100,000 * 0.02).
Then divide the total amount you’re willing to risk per trade by the amount
you are willing to risk per share to arrive at how many shares you need to buy. In

CHAPTER 25 Fixed Fractional Trading 301

Free download pdf