There was a discussion on leverage etc in one of the threads �A noob question on margin/leverage� that I participated. I would like to discuss this approach to risk management if I may.
To set the scene I take the view that 2% risk management is a common practiced level. In this example I assume that I have $2500 as my risk capital to start and my broker/dealer provides 1:100 leverage. I deal with a mini-lot which is 10,000 units. In the following example I aim to have 4 mini-lots on GBP/USD ($1 = 1 pip). If I open 1 mini-lot to buy GBP/USD then I am buying GBP with borrowed $10,000. With four mini-lot open positions, I am trading $40,000 against the equivalent of GBP. So with $2500 I will be leveraged at 16 to 1. Clearly that is too much so I have to mitigate the situation.
I only invest 50% of intended buy on a given trade at the start. That means that if I want to have 4 mini-lots of GBP/USD, I will start first with 2 lots buying at position P0 (leveraged 8 to 1). I will set my stop loss at 2% of $2500 or $50. That corresponds to 25 pips (1 pip movement equates to $2 in this case), i.e. stop loss at P0-25
I will then wait until I hit P0+40 pips so I am making $80 profit. I will then add another mini-lot (25%) at this point P1 = P0+40 [I]with stop loss of 1% of my remaining capital [/I]at P1-23 [23 comes from ($2500-$200)*0.01 = $23 or 23 pips]
At this stage I will shift the stop loss on the original P0 opening from P0-25 to P0+20
I will then add the final mini-lot (25%) at P2 = P0+62. My stop loss for this would be 22 pips , i.e. 1% of ($2500-$300) = $2200, P2-22
By then I have shifted my P0 stop loss to P0+40 from P0+20 and my P1 stop loss from P1-23 to P1+10.
The +40 and +62 pips position come from rough Fibonacci numbers (38.2 and 61.8). This is in a way for me to take insurance on my positions. But again this is not exact science
To recap.
a) I only commit 50% of my intended openings at start. If it went wrong then I will lose $50 or 2% of my $2500 capital.
b) If things turn against me after the addition of 25% at P1, I will then lose $23 from this position and would have made $40 from my P0 position (see 3 above). So a net gain of $17
c) If hell breaks loose after the final 25% at P2, then I will lose $22 from my P2 position, would have made $10 from my P1 and $80 from my P0 lots for a total gain of $68
These are my rough guidelines and figures and it does not work out all the time. I try to be patient and make sure that there is momentum in the pair before I commit those 25% positions. This may not be a textbook definition of risk management.
Price action and candle movements are great guides. If I feel at any stage that momentum is lost (I am watching it), I will then close all my positions and take whatever I have made. To me profit is profit at any stage. Look after the pennies and the pounds will take care of themselves.
Why is 16:1 leverage too much?? I don’t usually think of my risk in terms of used leverage, but 16:1 doesn’t seem too high to me… I do think that not enough risk is always better than too much, so if you’re uncomfortable with 16:1 then that’s fine.
I’m also concerned about the fact that your example seems to be using risk to figure stoploss, instead of using your stoploss to figure your risk. The markets don’t move because of your risk, they go where they go…
I do understand that it depends on your trading system, but more often than not this is not a good idea. You need to find a safe stoploss based on your charts, not figured from a calculator.
The rest of your plan, while a little too complicated for me, makes sense and sounds like a good money management plan.
This sounds similar to a MM plan I am trying to work out. I think your plan sounds good but it is complex. In a market that moves up and down through a trend you may have a hard time making it work. Limiting your loss is very important with any MM plan. If you cant limit your risk and loss any trading plan will fail.
I don’t know how long a typical trade of yours stays open. With a plan like this you will need to keep a close watch on any open trade. You may do this already so that may not be a big deal.
Phil mentioned why 16:1 leverage is too high. Well my understanding is that the norm is that one should not go above 5 to 1 leverage at any one time.
Now it really boils down to exposure. With 4 mini-lots open on GBP/USD at once I have a leverage of 16:1. With 2% risk limit for $2500 capital, I am restricted to $50 or 50 pips altogether. That means that my stop loss for this trade would be set around 12-13 pips. Taking the spread of three to four pips to cover before making any inroads, that leaves little room for manouvres.
I believe that for a relatively short term trading strategy like this, one needs to position himself/herself to get in when a trend is developing. How to do so is out of scope of this thread. For exit strategy I am mostly concerned with market sentiment and what candles tell me (with a bit of help from BB, RSI and Ichimoku). Again this is very subjective but there are occasions that I have closed the first 2 mini-lots position after 50-60 pips suspecting that the trend is running out of fuel. 50-60 pips is $100-$120 hard earned profit. Now if it turnes up that the momentum is still there and I was taken for a ride then I just open another position and see how it goes. The simple objective is to get out before giving it all back.
There’s a difference between true leverage and the kind of leverage your broker will brag about, such as 1:200.
True leverage means for instance that if your account has a 2.500$ balance and you open a 25.000$ position, then your true leverage is 25.000/2.500 = 10.
It’s the true leverage that we should keep an eye on and that’s probably where you got the 5 to 1 number from.
The technique you’re working on is a form of pyramiding up.
If you haven’t already, have a look here: Pyramid Your Way To Profits
Investopedia is a place I’ve found to be quite useful for reading up on terms and other things I come across.
thanks but when I open 4 mini-lots at $40,000 with $25,00 risk capital then my true leverage is 40,000/25,00 = 8 which is more than 5 that I mentioned?
Somewhere in the back of my head I have 10 as the max true leverage one should employ.
Personally though, I manage my risk by calculating the risk % per trade and I don’t pay much attention to true leverage.
Keep in mind also that not all of your 4 lots stand to lose their entire stop losses since you will have locked in some profit and made those lots risk free by moving the SL to break even or further past.
For that reason the true leverage may be relatively large while your total account risk is still kept at an acceptable level.
You are still under the impression that 2% risk somehow limits or determines your stoploss. This is completely wrong and if you trade based on that assumption it [B]will [/B]be your downfall.
You can risk 2% of your account with a stoploss of 1 pip or 10000 pips, or any other number of pips in between.
What broker are you using? It sounds like you might have a broker that only lets you trade whole lots and not fractions of a lot…
I trade with GFD/DealBook 360 both FX and CFDs. My current set up allows me to trade mini-lots. I can request for micro etc but not really interested. I tend to use the scheme I outlined earlier on and that works OK. As I explained in my earlier threads these are not hard rules and on occasions I enter a trade with lesser stringent limits or higher number of open positions if I feel that the opportunity is there. However, in general I adhere to guidelines I described in the opening thread…
My understanding from what you are suggesting is that 2% of risk capital (in the example $2500*0.02 = $50) is the actual amount that I could be using in trading at anytime. In that case as an example I can trade 50 micro-lots GBP/USD with that money and each pip will be 10 cents and the SL can be set as needed?
I’ve always been slightly confused about what is meant by “true leverage”. Is that relative to the size of the entire account or just the margin used to “purchase” a single position? Without adequate leverage, one could not make any money trading FOREX. Where am I going wrong?
I believe true leverage is simply the ratio of current open positions to your risk capital. For example, when I open 4 mini-lots (all positions are active] at $40,000 with $25,00 risk capital then my true leverage is 40,000/25,00 = 8.
Now in reality what one wants to know is how to handle that 2% risk. By that I mean at any time you should not expose your capital (or whatever remaining of it) to more than 2% of its value. I guess there are more than one way of interpreting this.
Let us assume that I have $2500 in our brokerage account. 2% means at any time one should not open himself/herself to more than $50 loss. That may mean to open one micro-lot with $50 and trade that $50 and one may lose that $50 altogether or do it the way I do it by opening say mini-lot where each pip is $1 (say GBP/USD) and make your stop-loss limit at 50, or two mini-lots with stop-loss at 25 pips. Bottom line is that at any time your total exposure to loss should not exceed 2% of your capital.
True leverage is defined as the added size of all your open positions divided by your account balance.
For example, if you have one 20 000$ and another 5 000$ position open and your account balance is 10 000$, that gives us 25 000/10 000 = 2.5 true leverage.
One more question on true leverage, how does it affect risk management in any way? After going through babypips school, its seems to me they are trying to tell us that true leverage are affected by the number of lots we put in and thus the more lots we add in, the higher the true leverage is and the riskier the trade is?
I and most others don’t use true leverage though, we instead figure our risk as a percentage of our account balance.
For instance, a trade with 2% risk on an 10.000$ account would mean that we risk 200$ (0.02 x 10.000$). That’s a simple and good way to manage your risk.
After that calculation you just figure out how many $ each pip can be worth then, which depends on your SL size.
For instance, risk 200$, SL 50 pips -> 4$ per pip.
You would then find the position size where each pip will be worth 4$.
