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Application of the fixed fractional (risk percent) method for calculating position size (the number of contracts traded each trade) requires that before a trade is opened, the exit price level (your target exit) must be known beforehand. Obviously, this method cannot apply to trading strategies with varying, or unknown in advance, exit price levels. This is a drawback of the method but it is also an indication that effective risk management can only be accomplished with simple position exit strategies.
The formula for the fixed fractional position-sizing method is obtained after one realizes that the amount risked on each trade must be equal to the fraction of the current bankroll one is willing to lose.
The amount risked on each trade is also equal to the difference between the entry and exit price, times the number of contracts.
The fraction of the current bankroll one is willing to lose on each trade is found by multiplying your bankroll by the allowable risk percent you wish to take (1%, 2% etc)
What does this mean? Basically, it means that you trade x number of contracts depending on both your trading equity balance and the stop loss you make on each trade. The risk percent position method is simple but very effective. It is evident from equations that as the account equity increases due to accumulated trading profits, while the position size (the number of contracts you trade per trade) also increases proportionally. The reverse happens when the account equity decreases. Thus, this method, even though it is fundamentally simple, is nevertheless dynamic in nature. It is also classified as an anti-Martingale betting strategy, as opposed to a Martingale one. IE: increase your bets as you win and decrease them as you lose.
Simply put, you determine how much risk you wish to take (1%, 2%, 3% or 4% - I don’t recommend any higher) of your trading equity, then determine your stop loss value (2 pts, 4 pts, 10 pts etc) for each contract. You multiply your risk% by your equity value and divide it by your contract value times “x” number of contracts. This will give you the number of contracts to trade per trade. The “x” number of contracts will determine how many contracts to trade per contract. Eg: you are trading the ES contract @ $50 per point. Your starting equity is $30,000, your stop is 10 points and you wish to risk 4% maximum per trade.
According to the “Position Sizing Calculator” (FREE on my website), you would then trade 2 contracts per trade. The calculator automatically determines the number of contracts to trade according to your input.
On the other hand, if you day trade the ES contract, and you start out with $10,000, you can place a 4 point stop and still trade 2 contracts.
Get the calculator and see for yourself.
Using this risk % or Fixed Fractional Position Sizing approach, you are never going to risk more than 4% (or whatever % you choose to risk) on each trade. No matter how many contracts you trade per trade. You are therefore controlling your losses, which overall, is the best method of money management there is available.
Control your losses and you control your future.
One of the weaknesses that traders start out with is being underfunded. Sometimes woefully underfunded. This in itself brings about a myriad of symptoms like fear, greed, lack of discipline etc. You end up bankrolling the other 10% of the traders that do not make this mistake. The calculator will let you know what is a reasonable starting equity, and if you follow its advice, you are that much closer to the upper 10% and your longevity as a trader is assured.
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