Possible change to the 1% rule?

Beginner Questions
1

Here is a bit of useless information that may be handy to other cowboys like me:

The general consensus seems to be that ‘you never risk more than 1% of your capital on any single trade’ and I have always just taken it mean that if you have $5 000.00 USD in your account you should not open a position that costs you more than $50.00 USD i.e. cost is 1%.

Well - here is the thing: if I interpreted it correctly then I think a better basis for the calculation of the 1% should be the cost of the lot + the cost of the spread = total risk.

Why do I say this? Because if you are interested in trading exotic pairs or commodities like Gold - you will notice that the spread is much higher because of the volatility of these instruments - so a slight movement either created profits or losses exponentially. In other words - buying 1 lot of EUR/USD for $50.00 USD is not the same as buying 1 lot of Gold for 50$.00 USD - trust me on this. In other words - let’s say that the cost of a lot is $50.00 USD and the spread is $45.00 USD then you should not be opening a position on this instrument unless you have $9 500.00 USD capital.

Now I am not going to tell you why I make this statement - let’s just say that because of the fg analysts on Bloomberg coupled with the banks in Europe fg with the Gold price and combined with my greed - my tuition fees have just gone up again.

Put it this way - and this is not joke - and please do not tell me to just cut losses - but I refuse to believe that there is no scientific method or algorithm that could be applied to hedged positions in order to close them out one by one without writing off the losing side of the hedged position i.e. there must be some way to ‘scalp’ either side of the swing until either break even or profit - particularly if you are hedged right in the middle of the range.

Oh - I can already hear the ‘I told you so’s’ - what can I say - on a high volatility instrument like Gold you would be suprised what a 550 pip change can do to your margin! Hence my advice above!

Regards,

Dale.

Oh - if anybody is in the mood to get involved with idea - please feel free. I now have $8 000.00 USD caught in a swing which I cannot draw down on!

2

I have ideas, but they are risky. I will not share them on the forum.

3

For crying out loud - I cannot send a PM to you - and I cannot change it in my personal settings (or at least - I have changed it but it still does not work).

Use this email address: <[email protected]>

Thanks.

Dale.

4

Dale,

I think you may be misinterpreting the 1% rule - my understanding is that you should be risking 1% of your account per trade, i.e. planning for a max drawdown of 1%.

Example:

$10000 account size
1% max risk ($100)

Say cable is trading at 2.0000/2.0002 (2 pip spread) and we want to go long. What position size should we take?

The most important thing here is our trading strategy, in particular where we plan to set our stop loss. Let’s say 20 pips form where we buy, which is 1.9982.

So, the max risk in this trade will be 20 pips, and 1% ($100) of our account.

If 20 pips = $100, 1 pip = $5

To make 1 pip = $5, we want to buy 5 micro lots, which is a position size of $50000, and we will effectively be using 1:5 leverage.

So what if it all goes wrong? The price drops, and we are stopped out at 1.9982, which is a 20 pip loss, which at $5 per pip, is a $100 loss. Losing $100 from our $10000 account is equiviant to a 1% loss. Assuming our stop loss order to be filled without slippage, 1% was the maximum risk on this trade.

Note the importance of our stop loss size in calculating our position size - if we wanted to use a 40 pip SL we would double our risk, unless we halved our positon size. If we changed SL to 10 pips, we could double our position size, while maintaining the same level of risk - we’d make more per pip, but probably get stopped out a lot more often.

The important thing is to determine positon size by the stop loss that your strategy requires, and level of risk you want, rather than choosing your stop loss based on the position size you want.

Risk (%) is directly proportionate to Stop Loss (pips) * Positon size ($)
So if we increase SL, we have to decrease position size, and vice versa.

If you want to work out the correct position size, you can use the formula:

Position size = (Account size * 1%) / (Stop loss size)
This should tell you how many mini-lots ($10000 lots) you can buy while having 1% risk.

5

Well now that makes sense to me…but I don’t think that’s the rule though.

I think it should be does anyone care to enlighten us on why not?

I would be interested in hearing why fronting %10 of your capital is riskier that fronting %1 as you only loose money in relation to pips and lot sizes…not on how much money you put up.

6

If you were responding to me, i think you are mistaken - there is a lot of misinformation on this forum, due to many people who don’t seem to properly understand leverage.

I don’t entirely understand your question, but the reason riskinng 10% is worse than risking 1% is that 10 losing trades will empty your account. Also, it is much harder to make the money back, for example:

Say you have a $10000 account, risking 20% per trade (20% is silly, but will help illustrate the problem. If you have a single losing trade, your account goes down to $8000. You might think “ok, i’ll just gain another 20% and be back where I started”, but inactual fact, you now need to gain 25% (i.e. 25% of $8000) just to get back to where you started!

This problem gets worse and worse - if you lose 50% of your account, you need to make 100% to get back to the start.

One of the biggest worries I have about people on this forum is the talk of using 1:200 or even 1:400 leverage. That much leverage is unneccessary - if you use it all, you are risking far too much of your account. The only reason brokers give such high leverage is to encourage newbies to sign up and risk more money than they can afford.

Example of 1:400 leverage:
Say I have a $10000 account, 1:400 leverage allows me to control 400*10000, or $4000000. That’s 40 full lots, which is $400 per pip! That means if you lose 25 pips, your account is down to zero. Moral of the story? Never use 1:400 leverage - even 1:200 is too much. I can personally never see myself using more than 1:50 - and that would be 5% risk per trade (very dangerous) with a 10 pip stop loss (smaller than most). 1:10 is a fairly sensible everyday maximum, and I would happily open an account with a broker which only offered 1:10.

7

My friend, have you ever considered there may be more to understand. :slight_smile:

I do understand as you do, and more. :cool:

You sound like another, just a new name. Hmm…

Thanks for you opinion.

Much appreciated.
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8

Actually, I think I might understand what you’re getting at now. The money you “put up” is irrelevant. If you buy one minilot, your position size is $10000 - that is always the case. You don’t really “put up” anything with most brokers - leverage means that they pay for some of the position for you, but you still control $10000.

If you had no leverage at all (1:1), you would need $10000 in your account.

If you had 1:10 leverage, you could have the same position with $1000

If you had 1:100 leverage, you could control the $10000 position with only $100

In each of the three scenarios above, you have the same size position, however you control it with a different amount of money. In each case, 1 pip represents $1, so your risk in $ is the same. The problem is that your risk as a percentage is completely different.

With 1:1 leverage, a 10 pip loss would mean losing $10, which is only 0.1% of the account.

With 1:10 leverage, a 10 pip loss is still only $10, but this time it is 1% of the account (still quite reasonable).

With 1:100 leverage, a 10 pip loss would be $10 again - 10% of the account!

Hopefully this shows you that how much you put up is not the most important thing - position size (money put up * leverage used) is the key to determining risk, as this decides how much the pips are worth.

9

[I]Edited for content[/I].

Here’s what I’m saying here:

Say you have $10,000 and you put up %10 (1,000) with 50:1 leverage. That’s 5 mini lots. $5 a pip. If you loose 20 pips that’s $100 or %1.

Okay then, let’s try something else.

You have $10,000 and you put up $500 (%5) with 100:1 leverage, that’s 5 mini lots. You loose 20 pips and $100.

Again only %1 risk.

I think the trick is calculating your risk parameters when entering a trade. Because either you put up $500 or $1,000 but ultimately you only loose $100.

Correct me if I’m wrong…oh yeah I forgot the spread, but you can factor that one in yourself.

10

If I am wrong, could you explain leverage, margin, and risk management to me? Or tell me where you learned about it. I don’t claim to be an expert, but I have read a few books and have spoken with a very successful trader (millionaire in fact), and thought I hadit figured out.

I’d love to hear your explanation though. :slight_smile:

11

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Many speak of leverage being a double edged sword.

Help me understand this double edged sword.

I use 400:1 leverage and I don’t use stop losses. :cool:
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12

Yeah, I think we’re on the same page. All my examples are assuming that you put up your entire account balance on every trade, while still only taking 15 risk. The important thing is the size of the position relative to your account - after figuring this out, the amount put up depends on leverage, so we are in agreement - I just misunderstood your other post.

13

My trade style needs no money management. Money management takes care of itself.

No body explained it to me. I just listen to the wealth speak. (above millionaire)

I mean no harm. You may or may not want to continue your research.
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14

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Most people are looking for the big “POP” in the forex market to make money.

My trade style nibbles, and nibble, and nibbles some more. Untill I have a tummy full. :stuck_out_tongue:

Did I say tummy, I meant bank account.
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15

I fear that you are in the minority there - most new traders fail, usually due to lack of trading education and money management. Think of trading as being like brain surgery - you might get lucky and figure it out yourself, but most people take years to learn.

I think it’s worth mentioning that the best traders, i.e. the pros working in banks and hedge funds use strict money management - in fact they have entire teams of risk management people to make sure the traders are manageing money properly1

16

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LOL, everyone will understand one of these days. :smiley:
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17

Well at least we agree on that! I presume in that case that if you are using 1:400 leverage, you must only be using a small percentage of your account at a time?

18

Cool man, believe as you believe. :slight_smile:

I know as I do and you know as you do.:cool:

The market can sort it out. :smiley:
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19

You bet man. :stuck_out_tongue:

Love to you family from my family.
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20

I posted this earlier,

Check this out. The bank always says “you house is a very large asset”. What they don’t tell you is to whom. The bank makes about 3x what your house is worth over 30 years. An asset brings money into your pocket. If your house is mortgaged, you will pay about 300,000 for a house that is worth 100,000. Sounds like the house is an asset to the bank, not the home owner. You can check these figures in various places online. Or take your house payment and multiply it by 360(12mo. x 30yrs). I’m sure the figure is greatly more than the value of the home. The bank may say something like"Finance Charges :o ".

So maybe the bank had the many hold on so the bank could be the one to profit. I realy hope I am wrong.

So, maybe the banks hide the real use of leverage from the masses.

Maybe not, but I think maybe they do. :cool:
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