Why only 1% Capital Risk when trading

[Gardan]

Hi,
sorry - busy night...
NAsdaq - your risk, in the case suggested, is that you are only exposed to the US market so it can crash mightily, turn your investments to dust, while the rest of the world could theoretically be just fine and carry on as normal. Having said that as a sort of standard disclaimer I'd say that trading is 'intellectually stimulating enough' that you simply can't devote 80% of your brain to hedging against what ifs. Ultimately the more eggs in the basket the better, provided you don't have so many that egg management interferes with your reason for being in the farmyard in the first place.

Diversification can be taken too far, in my opinion, and if you can say 'if this market I have a trade in halved in the next minute, would I be relatively okay with that?' then that's a decent rule of thumb. If a halving market - which is way worse than you would ever expect to see happen - would kill you off then you should look at maybe trying to get a more even long/short balance. I'd consider having two profit warnings, each costing up to 50% (the converse is also possible - somebody invents a cure for the cold and their shares double... not good if you have them as a short) as the most I'd expect to hit me in one go. Being able to handle that is probably more than you'll actually need. It's the risk:reward game as usual - overexposure to a catastrophe whilst having it all on red can be a big winner, but the damage is greater if the worst happens.

All that's just opinion of course, I survived profit wearnings and the like because when one share got hit it only had part of my money in it - if you had 10 shares and were fully invested then that might be a 5% overall loss... that won't take you out, it'll just sting a bit! A 9/11 event might take 50% if you are fully invested, long only - if you are 50:50 long/short you might well be untouched... so it's worth considering ways to keep invested but still reduce risk - using a range of tactics, some as simple as shorting, makes sense provided you don't complicate things tot he point your trading is rubbish.

Guranteed stops - you get them with things like spreads, I wouldn't be surprised to find them on offer in other areas - when I make a bet the company put a stop under it, usually a laughably big gap away so I then set it much closer. I could pay a slightly bigger spread and if the price gaps past my stop the SB company should honour the stop I set, despite the fact the price fell past it.
I don't use this myself, not least because the stops are limited in how close they can be to the current price, and they insist on too big a gap frankly - so I watch the screen, write my stops down as the price moves, and exit manually. They would be more useful to me if I held overnight, as a gap the wrong way could cost a few bob!


Gaps - not as excited by it as you <g> I'm interested in them for support, resistance, their tendency (quite often) to be filled, and the way the MMs generate them to take advantage of the herd at the open.

Dave

Phew! , cheers Dave, I must be more considerate in the future when asking so many short questions. Thanks again for your time and the detailed answers/views.

Gary

 

[JumpOff]

Tony, Re the under-capitalisation bit, is it fair to say that as a trader builds up his pot of lolly. He/She may have to take a few more risks with there capital (not with there stops). Say, risking 5% -10% in the market, until the pot is large enough to use your more prudent risk management?
If not how will the trader survive trading prudent small amounts, without getting nailed by all the fees.....

I believe the trick is to learn to sit on your hands and follow your plan. So many new traders sit down at a screen and assume that there will be a great setup in the next 5 minutes. - but setups don't come just because you've decided to stare at a screen this morning and have an idea that you want to trade intraday...

When I look at my worst days, I was trading without a plan, and at the end of the day it was really embarrasing to review the chart and realize that 10 out of 12 trades had no reason for entry (because there was no reasonable place to put a stop loss order).

Although simulated trading can't prepare you for the emotions you'll experience when trading real money, they provide an excellent method to journal and review your actions and check your plan. It's amazing how fast an account can go down if you are trading on 'gut feel.' It's useful to trade that way through 10,000 paper dollars just to see how fast it can go - and how much more slowly it drains away at 1% per trade.. The 1% rule gives you some time to see if you really know what you are doing. If you can't make your paper account go up consistently - then there is no reason to put real cash on the line.

Here's an interesting exercise. Put $1,000 in a spreadsheet cell, add 1 percent to it per day compounded, and watch it grow. Your little $1,000 pot can grow plenty fast enough. Now take another cell and put $1,000 in it, and subtract 5% per day compounded. You can be back at the grindstone in no time.

JumpOff

 

[DaveJB]

A few good points in there, although I think you've got to look at the timeframe and what you are trading as well - anybody buying shares, non-margin, with a view to holding for a few weeks to years is hardly going to be exiting after a 1 day price drop of 1% - hence the popularity of such delights as the 10% trailing stoploss. On the other hand when trading short term intraday moves a stop under a bar might be just a few cents away, and be a fraction of a percent if you bothered to work it out. What you are trading, and how, makes a difference to what constitutes a sensible level of exposure and risk.

Plans are definitely good things to have <g> As for good setups, too right....

Gary, risking more early on so you can build a pot up to be cautious with - to be truthful I think if you do the first bit you'll not reach the second. You should be trading in a manner that allows you to build your pot up, not necessarily all in one month, and having figured out the likely risk of trading whatever you are inclined to try, you should then see if your pot is big enough to allow you to trade that for worthwhile gains whilst maintaining a sensible risk level. (Phew!)

ie if the trading pot is small then there's not much point picking a tactic that offers 2% a month when you get it right, and deciding that you need 20% so you multiply the holding by 10 to make the numbers come out right... you need to find an alternative item to trade that allows you to invest what you know to be a sensible amount of your total pot, where the return is worth having, and you are comfortable with that instrument and style of trading. Increasing the risk because your target is too far away or will take too long to reach is a mugs game.

Dave

 

[Gardan]

A

Gary, risking more early on so you can build a pot up to be cautious with - to be truthful I think if you do the first bit you'll not reach the second. You should be trading in a manner that allows you to build your pot up, not necessarily all in one month, and having figured out the likely risk of trading whatever you are inclined to try, you should then see if your pot is big enough to allow you to trade that for worthwhile gains whilst maintaining a sensible risk level. (Phew!)

ie if the trading pot is small then there's not much point picking a tactic that offers 2% a month when you get it right, and deciding that you need 20% so you multiply the holding by 10 to make the numbers come out right... you need to find an alternative item to trade that allows you to invest what you know to be a sensible amount of your total pot, where the return is worth having, and you are comfortable with that instrument and style of trading. Increasing the risk because your target is too far away or will take too long to reach is a mugs game.

Dave

Dave, apologies for late response, builders are in, you know the score, sit at your PC and then they call you to ask your opinion/agreement on a small area they are working on,as to why it will
take another two weeks to complete the small task, oh opps...it may effect the original quote too! SUBSTANTIALLY Mr you thought we wern't getting a tan out of this job JONES.

Anyway (sorry but I feel much better now) I think my original reference to taking a bigger risk with a small pot, was the Numbers Tony & Paul where quoting. The main query was, against small trades would the commissions & fees not kill a small pot trader before a poor system?

Gary Smith

 

[Gardan]

I believe the trick is to learn to sit on your hands and follow your plan. So many new traders sit down at a screen and assume that there will be a great setup in the next 5 minutes. - but setups don't come just because you've decided to stare at a screen this morning and have an idea that you want to trade intraday...

When I look at my worst days, I was trading without a plan, and at the end of the day it was really embarrasing to review the chart and realize that 10 out of 12 trades had no reason for entry (because there was no reasonable place to put a stop loss order).

Although simulated trading can't prepare you for the emotions you'll experience when trading real money, they provide an excellent method to journal and review your actions and check your plan. It's amazing how fast an account can go down if you are trading on 'gut feel.' It's useful to trade that way through 10,000 paper dollars just to see how fast it can go - and how much more slowly it drains away at 1% per trade.. The 1% rule gives you some time to see if you really know what you are doing. If you can't make your paper account go up consistently - then there is no reason to put real cash on the line.

Here's an interesting exercise. Put $1,000 in a spreadsheet cell, add 1 percent to it per day compounded, and watch it grow. Your little $1,000 pot can grow plenty fast enough. Now take another cell and put $1,000 in it, and subtract 5% per day compounded. You can be back at the grindstone in no time.

JumpOff

Good advice I think JO, what's you handle on the capital risk base numbers?

 

[DaveJB]

On that basis, then I'd be more inclined to agree - but you know what comission etc fees you'll be paying (about the only part of trading you can be sure of) so you can reasonably figure out if your method is worth pursuing. There's a fair range of ways to trade these days, I think I'd be inclined to pick the timeframe and method etc with at least half an eye on what's feasible without compromising what you consider sensible rules aimed at keeping you in the market for the long run.

It really rather boils down to whether you think only having 10% invested will be enough to make a profit you could be bothered to count. If yes, then why not take the safe route? If no, then there's no point being exposed to any risk if the reward isn't worth having. Which cycles back to where we started, I suspect - my opinion is that having 90% of your cash sitting unused is too cautious.

Good luck with builders - they have to make their money somehow now that they're running short of 'buy to let fixer uppers' programs to appear on. We had some in over summer hols (left 'em to it, with a friend keeping a close eye <g>) Had a delivery dropped off today, nobody in, but he's definitely been in the building trade at some point I reckon... 'Left parcel in greenhouse' his note read - even my wife (delusions of grandeur notwithstanding) calls the thing a cold frame like the rest of us....
Dave

 

[Gardan]

Good luck with builders - they have to make their money somehow now that they're running short of 'buy to let fixer uppers' programs to appear on. We had some in over summer hols (left 'em to it, with a friend keeping a close eye <g>) Had a delivery dropped off today, nobody in, but he's definitely been in the building trade at some point I reckon... 'Left parcel in greenhouse' his note read - even my wife (delusions of grandeur notwithstanding) calls the thing a cold frame like the rest of us....
Dave

Re builders:The problem I have Dave is, like my trading, do I buy/sell or hold? where do I put stop loss? LOL
The fundamentals looked good too, when I got them in but now I'm invested.......Mmmmm?

 

[JumpOff]

Good advice I think JO, what's you handle on the capital risk base numbers?

Let's put the horse in front of the cart. Before you can decide how much of your pot to risk per trade, you have to have a trading plan that allows you to take an educated guess at how often you'll experience a drawdown instead of a net gain. If you're a new trader, you have to assume you won't be able to execute your plan in real time the way you did on paper, so it makes sense to add in 10 - 20% slippage on those numbers. How many trades to do you need to make in order to have a sample worthy of evaluation (how many times did I pull the trigger exactly according to plan specs, how often did those trades results in gainers, losers)? Since it's unwise to change your plan while you are trading, if you need 100 trades to make a preliminary evaluation of your real time adventures, then check out this scenario:

Let's say that on paper, you can average 2 gaining trades of $180 net each for every 6 trades where you get stopped out a -$30 net each. It wouldn't surprise me to find that when 'going live' you actually have 8 losers for every 2 gainers. And given the vagaries of fate, you could possibly see 24 losers in a row - even while maintaining your averages (don't ask me how I came up with 24 - it was just a guess - perhaps one of our esteemed statisticians could help here).

So If I start with a small account (say $10,000) and 100 trades later I am up $1,200, but had to suffer through at least one period where I went straight down $720 in one agonizing swoop, am I comfortable with that? Is there a beginning trader in the world who wouldn't be satisfied with those overall results? (If you think that's too much effort for the gain, then I think you are suffering from delusions of grandeur)

10 x ((2 gainers x180) - (8 losers x30)) = $1,200
That's acually just 0.3 percent risk per trade, assuming that the markets are steady and don't gap through your stop loss orders. It leaves you room to step aside and lick your wounds if the market does gap through your stop and leaves you down $500 on one trade.

The primary goal for any new trader is to live to trade another day. If you have a solid plan, your account will grow and you'll be making real money soon enough.

JumpOff
*note of caution**
You should be aware that although my tag says I'm a veteran member, that just means I write a lot. - So far - I can't trade for sh*t (even on paper!), which is why I'm still working a trading plan before I put my cash in the market.

 

[DaveJB]

Risking losing $30 on $10,000 is indeed 0.3% - but for it to be 0.3% risk you would therefore have to have all $10,000 on a single trade....and to put your entire pot on a single trade isn't risk, it's suicide.... you have no idea of if and when you'll gap straight past your stop and be taken for rather more than the planned $30.
If, for example, you made 10 x $1000 trades, and each had a $30 stop, that would be 3%... which brings up back to the question of whether somebody with a $10,000 account can usefully trade with a stoploss underneath the longs that's closer than the comission paid to make the deal <g>
Dave

Dave

 

[JumpOff]

Risking losing $30 on $10,000 is indeed 0.3% - but for it to be 0.3% risk you would therefore have to have all $10,000 on a single trade....and to put your entire pot on a single trade isn't risk, it's suicide.... you have no idea of if and when you'll gap straight past your stop and be taken for rather more than the planned $30.
If, for example, you made 10 x $1000 trades, and each had a $30 stop, that would be 3%... which brings up back to the question of whether somebody with a $10,000 account can usefully trade with a stoploss underneath the longs that's closer than the comission paid to make the deal <g>
Dave

Dave

whoa there! I hope I'm not trying to drown in a mud puddle. - I thought I made you folks promise to warn me if I start to do that again!

When people say don't risk more than 1% of your trading capital per trade, - I thought they were talking about finding a position size where a stop loss equal to 1% of your capital is reasonable, - particularly in an intraday liquid market for a popular stock or something like the e-mini Naz or S&P, where the price rarely gaps more than a few pips. You need to know if 1% of your trading capitial is bigger than the noise associated with the intrument you are trading - for that position size. This is like saying, "for this intrument I trade, if I want a really tight stop, how many pips do I need to allow - just for the way it wiggles. If the answer is 10 pips on the average setup, then the ratio 10 pips : your position size = 1 : 100

I thought this whole discussion was about 'not getting carried away with using leverage', or 'putting 20% of your capital in one trade with out with out a stop and watching it go to zero'.

Dave, are you saying a trader with a $5,000 account should only use a $50 position size? (Is there any liquid instrument you can trade with $50?)
JO

 

[frugi]

You are both right

Futures trading (and leveraged share trading) muddy the water because the notional size of a position can be larger than one's entire capital, yet the margin required will be much less. e.g $50k of Dow can be controlled with $2k within a $10k account.

Simply measuring risk by stop loss is not entirely satisfactory because one must think both in terms of amount risked assuming it is hit at the predetermined price, and amount risked assuming it is missed by a wide margin. The latter is a matter of complex probability, unfortunately.

So how much is risked for a given position? Clearly the margin isn't the total amount risked, it is merely the amount required as a float to keep a position open. Any adverse movement that takes the account below minimum margin requirements for that instrument will elicit a margin call in direct proportion to the number of contracts/shares open. However I think it would be fair to say that the margin posted at any point represents "capital employed", if not capital risked.

If trading only intraday theoretically one's max risk is simply the amount of points lost before the stop loss closes the position, assuming no slippage or, worse, catastrophe. But I am of the view that (with regard to the instrument I trade) as long as one has a stop in the market the intraday risk of losing far more than expected is minimal.

A 1% loss of my pot of $10000, trading at $5 per point, is obviously $100, which translates into stop losses as 20 points per one contract, or 10 per two, or even 5 points trading four contracts. The net loss is almost always 1% of total capital, regardless of postion size. (By "almost" I do not mean the times I move a stop adversely but the times when a stop is not hit at chosen level due to no bid/offer). Actual capital employed "locked in" per trade is the amount of maintenance margin required, assuming the stop loss is sufficiently close to be triggered before a margin call arrives.

I think I'm going round in circles, I'll leave it there.Everyone has different attitudes to and tolerances of risk, we've just got to define a position with which we are comfortable (and more importantly of course one which will not kill our account if we have a number of losers)

 

[DaveJB]

Arf!
Thanks Frugi, and I certainly wasn't biting you Jumpoff <g> I think maybe what has to be considered here is almost a case of 'define risk' - to me, if you had 10 x $1000 trades (and I suspect people with that sort of small pot have tried thoser sort of numbers) and they all happen to be in the Nasdaq long, then all 10 might well have stopped out today if held over from yesterday. If each one is a $30 stop then you're out $300 at that opening gap, or at some point during the lows up to the close. On the other hand, a single trade of $10,000 will have exited on a $30 loss - your 0.3%, my 3%. My point being that nobody with a $10,000 pot is going to plonk it all down on one trade....

If you DID plonk it down on one trade then on paper your stop limits you to 0.3% - okay, so on 10 Sep 01 my favourite horror story Honeywell closed at 35.70 (adjusted prices - don't ask me to go over splits etc <g>) and when the markets came back on the 17th it opened 31.29... a loss of $4. 41 which, with all $10,000 invested, would have netted a less than enjoyable loss of something like $1235 and change. Now that's on a simple 1:1 stock buy, no leverage of any sort. Is the stop you set a measure of risk?

I'd contend 'no it isn't' - the stop you set is simply a measure of how much you are willing (kicking and screaming doubtless) to endure - but the market is not compelled to pay any attention to it at all. Now risk is what takes your money off you - and it's what I consider 'real risk' that does that, ie what the market MIGHT do, not what I'm willing to allow it to do. The real risk is doubtless something that at least 200 T2W members can calculate, I'm a seat of the pants type on it (confession time) - you need to have a substantially correct estimation of what the actual losses on your account might equal if you do what you are planning to do - risk is 'if I jump off this cliff I'll probably die' not 'I'm prepared to accept a sprained ankle if I do it'. I'm not being funny here, although I'm putting it in a lighthearted manner - I'm just doing that to try to emphasise MY take on risk... risk is what you might lose, not what you want to limit losses to.

You CAN pay extra to have a guaranteed stop loss - ie it gaps, you're out at the price you set - but it costs more and isn't available on many instruments (as far as I am aware).

In my version therefore you don't put large percentages of the pot into each trade, as that is risky - you risk a single unusual event costing you too big a percentage at a stroke. If your pot is divided amongst a lot of trades, with no single trade using more than (ballpark) 10% of your pot, then a single catastrophe is going to cost you 10% and you will survive to try to get it back. Multiple hits (9/11) will severely damage those who only trade one way - have long and short trades to partially negate the risk from the market, and in my version of reality you have reduceds risk without having to reduce the sum invested in each trade.

I'm generalising here quite a bit and uncomfortable with it, there are doubtless equations to cover this sort of thing, and studies up the yin yang... I just go with the 'eggs in one basket' aversion and figure the more 'edges' I get, the less likely I am to find myself in the OK corral with a cheese knife.

I'd like to stress JO that I'm not having a pop at all - a significant issue in all this is what you are trading, and what you can do with it - there's a world of difference if margin is involved, if you can short, and so on.

Dave

 

[frugi]

 Think I might have just won the monthly TV prize for obfuscating the obvious opaquely, or summat, oops

Risk $ per trade = ( stop loss * contracts * $ per contract ) + ( $ amount of all unexpected losses beyond stop level divided by all trades taken, past and future, until you stop )

All the same, an exponential or bell curve I'll bet. Lots of small $ losses (slippage), some medium ones (gaps), a few large ones (suspension) and the very occasional gargantuan one (Salty Gibbon says sell).

Percentage of what? Total capital, notional capital or capital employed (margin). You choose!

 

[DaveJB]

And this is an attempt (fruitless) to reduce my 'words per post count' below that of the Encyclopaedia Britannica.
Dave

 

[Gardan]

JO-Dave& Frugi,
After looking back at all the post on this thread thus far, it has been great to see the different opinions/views.

I think also there is much confusion (me included but feel I understand it more now) on the 1% risk of capital risk, in as much as some see it from a stop loss base and others from the total value of shares they are tradeding in.

I think it would be really interesting if a poll was conducted on peoples views. Problem being I am unsure how to administrate a poll, plus the questions need to be clearly worded. Any of you guys interested?

Gary

 

[DaveJB]

Naah.
(Wordcount/posts drops another notch <g>)... omits name to save another notch...stop typing you fool, the master plan is all going awry...

 

[frugi]

TrymakingyourpostsonlyonewordlongDave

No, actually don't cause they're always quality.

 

[Gardan]

Naah.
(Wordcount/posts drops another notch <g>)... omits name to save another notch...stop typing you fool, the master plan is all going awry...

Yep = three letters, come on Dave you know you would love to.

G.

 

[DaveJB]

!

 

[Gardan]

!

I'll take that as a YES, looking forward to it......Off to our/your Capital tomorrow for the weekend, look forward to seeing your poll on Monday.

Anyone know a decent Haberdashery, thats makes quality caps?
A good pub that's sells a decent pint of Brown Ale and pickled eggs would be good too.

Will I need my passport??

Tararrrrrrrrrrrr