HOW MUCH MONEY SHOULD YOU RISK?
One aspect you should pay special attention to is that of:
Position Sizing
The classic mistake I see many investors, both new and seasoned alike, consistently make, is over-concentrating their capital into a single position.
Today, I'm going to show you the best way to size your positions to save you a lot of the pain (and money) that other investors are encountering.
Position size must be determined not by how much money we hope to make but instead by how much money we are willing to lose if we are wrong!
That's a subtle but important distinction.
My 4% Rule
Being wrong is just a part of ultimately being right. The key is to make sure that, when you are wrong, you don't lose too much of your equity while you are on the road to being right. My general rule of thumb is to risk no more than 4% of your starting equity on any individual trade. 2% would be better, but 4% is acceptable.
Let's assume that you have a $40,000 account. Does this mean that you only put 4% of $40,000 into your trade?
No!
The 4% is the amount you are willing to lose if your futures position gets stopped out. In order for this technique to work, it means that you must attach a stop-loss to each of your trades. A stop-loss is an order you put in with your broker that will get you out of the trade when the futures contract hits a certain point.
We use stop-loss points to manage our risk.
Here's How it Works
Let's work through the following example. 4% of $40,000 is $1,600. That means if your position hits your stop-loss point your position size is such that you will lose no more than $1,600. To take this a step further, let's assume that you want to buy an emini s&p contract, and you want to figure out how many contracts to trade and lose no more than $1600.
Each emini s&p contract is worth $50.00. Once we know where our stop-loss point is, we can begin to work out how many contracts we can buy. To do this, we simply multiply the starting equity by the % you are willing to lose and then divided that by the stop loss you are going to use times the value of each contract value.
Your starting equity is $40,000. Your risk is 4%. You then have to figure out how many points your program stop loss is and as you intend to trade the emini s&p contract with a value of $50.00 per contract, then with this information, you can determine how many contracts you can safely trade. If you lose that trade, your maximum loss will be $1600.
You can always get a large sheet of paper and multiply and add until you come up with the answer.
The simpler approach would be to download the FREE “Position Size Calculator” on my web site.
The proper answer is 8 contracts. Your maximum loss if you lose all 8 contracts is $1600.00. (You can determine the proper number of contracts to trade, for your own particular situation, quite easily with the calculator).
Knowing this, and with a $40,000 account, you would have to lose over 12 trades in a row before you lost 50% of your starting equity. At 50% loss, it is incumbent on you to stop trading your system, and try to determine what you are doing wrong.
Keep Your Powder Dry Till Your Guns Start Blazing
By using this approach, you prevent yourself from over-leveraging your positions and creating unnecessary stress. It also allows you to make several attempts to get into a position without risking too much money.
Hope this helps.
