Mastering the risk on each trade is the basis of a clean trading. Most of the time the novice traders do not take into consideration the "loss" in their trading system, only the potential gain is evaluated. The worse, some of them take position simply by looking at the leverage that their position will use.
The money management or capital management or risk management is to manage the trades on several factors.
- On each position trader must know what part of his capital is ready to risk and based on this parameter he must adjust the size of the position and / or the level of his stop loss.
- Once in position, the trader's objective is to maximize profits and minimize losses. Maximize profits will require to reinforce your position as far as the market give you right. it's called "pyramidage" (used in the method of dow). The protection of profits and limitations of losses consist to change stop loss as far as the price evolves in the anticipated direction.
- The output of positions is also important. It can be done on purpose, Stop moved and finally executed, or even spot where the trend is showing signs of weakness.
This concept should be known by every trader because it allows you to preserve capital and significantly increases the probability of its portfolio to appreciate.
Calculation of position
Amount = higher risk in the currency traded / number of pips to the stop
example : EUR / USD is priced at 1.4200. We want to risk $ 1,000 on 100 pips.
So, we take a position of:
1000 / 0.01000 = 100,000 Euros.
NB: It is possible to settle your highest risk in the base currency of your portfolio, but the final result of the trade will be approximate. Why? Because if for example you trade on USD/CAD (Profit or loss in CAD) and the base currency of your portfolio is the Euro (currency used here for the max risk), the EUR/CAD parity will necessarily move during your trade.
Example:
Portfolio in Euros. Long position calculated on 100 euros of max loss, stop loss at 50 pips.
USD/CAD priced at 1.2000/05. So Long open at 1.2005.
EUR / CAD priced at 2.0000/05.
Calculation of the position: (100 euros * 2.0005) / 0.0050 = 40,010 USD
We are stopped at 1.1955. But during the length of holding, EUR/CAD goes down at 1.5000/05.
We settled a maximum risk of 100 euros. In this case, our loss is:
((1.2005 - 1.1955) * 40.010) / 1.5005 = 133.32 euros.
Conclusion: It is preferable to set a maximum risk in the currency of the trade. (here: CAD for the example)
Where to move your stop?
If your trade is in the right side, then seek to maximize the profit. So, we will move the stop according to the evolution of the price and not cut your position on a small profit (the movement can only be at the beginning). But where to move your Stop?
You can move your stop on a last highest/lowest point, on a Super Trend, or other ... (Ask for advice on the forum)
But always think to look at the offered price if you are Short, and at the price asked if you are Long because the spread is often forgotten in the settlement of your stop.
It is also advisable to add / remove a few pips to stop in order not to be typed stupidly.
(Indeed, if for example you are long, last lowest price asked at 1.4210, you should not settle your stop at 1.4210, but just below according to the timing. It avoids your trade to be cut on a double Top or Double Bottom)
