I’m very new to forex and have only gone through Babypips school, read a few ebooks, and lurked in a few forums (including this one ehehe). If anything, I’ve realised that good money management is essential. And I’m thoroughly confused by it.
I have a simply stated goal of achieving 20pips a day, and am going through the thought process of achieving this. Let’s say that I develop a system with 60% accuracy and 1:1 risk ratio (not wise, I know, but bear with me please). Given that I will lose 40% of the time, does this mean that holistically speaking, after 10 trades I come out with 2 profitable trades (6 winning - 4 losing)? Meaning those 2 trades need to be able to make me 20 pips, or 1 trade gives a potential reward of 10 pips.
If that’s the case, given the 1:1 risk:reward ratio, does that mean my stop loss should be 10 pips? But I’m advised that anything less than 20 pips will put me at the mercy of whipsaws and market volatility.
I suppose what I’m asking is, for those who scalp or have profit taking levels around 10-20 pips, how do you determine your stop loss? Do you operate with a 5-20 pip stop loss?
Apologies if my question makes nonsense and hope you can be a bit merciful on a forex newbie. Hope you can point me in the right direction :o
If your profit objective is 10-20 pips and your exercising a 1:1 risk to reward ratio, then your stop loss would also be 10-20 pips.
The rule of thumb when it comes to risk per trade is 2% of your trading equity. And I also like to adhere to a 3:1 reward to risk ratio.
So in your case, if your profit objective was lets say 20 pips. With a 3:1 reward to risk ratio you should operate with a 6 or 7 pip stop loss.
This rule is not etched in stone however, it all depends what time frame your going to be trading, how much equity is available in your account and how volatile the market is that you’ll be trading. So adjust your stop loss amount accordingly based on the factors I’ve outlined above. But the 2% and 3:1 rules are good starting points.
Thanks BWise. I was questioning the validity of using small stop losses, but going from what you said and the lack of comments on using a 6-7 pip stop loss, do you mean that small stop losses are not uncommon?
Is it safe for me to assume that small stop losses are ok depending on the strategy in question? Or should a trader, in the development of a strategy, avoid using any stop losses that might be caught in a whipsaw or market volatility?
For your intended purpose of scalping, a 6 or 7 pip stop loss is reasonable, since your only looking for a minimal amout of pips (10-20). Remember a scalp trade is done a very short time frame (ie. 5min, 2min, etc).
I wouldnt advise you to use the same stop loss on a 1hr or Daily time frame because it is here that you would expeience the whipsaw and be stopped out of your trade. So the larger the time frame the more breathing room you`d require to allow your trade to formulate.