Capital Management - from theory to practical application
We often hear the cliché advice, sort of:
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Never adventurous than 2% of your capital on each trade
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Cut losses early and let profits as large as possible
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Only trade when the ratio in order win / loss from 2/1 upwards
Etc. and etc.
That's the golden rule of trading, and nearly everyone knows that.
But few people know how to apply them like?
How do you know what point in time should stop loss is, how do we have a winner at 2/1 ratio on actual transactions?
But you can not answer that question if you do not understand his strategy.
So, instead of focusing on your desired account this and that, focus scrutiny you're doing with your trading account.
The analysis of each order transaction, basically can decode all. It will respond to the following questions:
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Percentage of Profit / Loss of trading strategies is how much?
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Percentage win / loss is how much your
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The string of losses usually how long, how many orders?
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Order the biggest hole be?
Answer 4 questions will help you better control your account.
(To have these things you have to Backtest strategies with standardized
data for 1 year. If not, it is just starting to go. Oh, how Backtest
???? In another post I will provide detailed guidance)
Calculation:
Percentage Profit / Loss:
% Word: The command win / Total trade X 100%
% Loss: 100- word
% / Profit / Loss% the number of commands in the command word hole. For example profit and loss ratio is 2: 1, it means that on average every two commands will have one command hole wins.
Percentage win / loss = total number of words on trade wins / losses on total number of lost trade
Example: Percentage win / loss was 3: 1 means 3 contracts on average you will earn 1 yuan loss
The longest string of losses: As of command most consecutive losses in trading history. The total value of those losses will tell you do not have the money necessary to be able to survive the losses that stage.
Orders biggest loss: The loss of trading orders most in history. Like the string of losses, the value of the largest hole command will tell you how much need capital to survive.
Practical application:
If I want to achieve a winning ratio is 3: 1, but only gained 2: 1,
further risk each order is too big or too small odds, then I need to
review strategic transactions and modify accordingly. If
you have achieved a ratio of 3: 1 or better still, I do not need to do
anything, or may consider lowering the risks in order to optimize
revenue.
If I wanted to profit and loss ratio 2: 1, but only achieved a ratio of
1: 1, it means there are problems with the location in order. I need to review and modify strategies. If
I achieve this rate, then there is no need to do anything or further
improvement in order to reach the point of optimal performance further.
If I want to know the amount of capital needed to survive the hard times
that, I can use two criteria combined value of the longest string of
losses and the biggest loss orders in order to find reasonable answers .
For example:
2014 I opened a $ 10,000 account, each order 1 lot traded under the ABC strategy, with a total of 65 transactions / year. In order to win 42 (64%) and 21 lost orders (32%), break-2 command (4%). So on average every 3 orders I won 2 lost 1, profit and loss ratio is 2: 1. This is a reasonable rate. However, to further clarify, please pay attention to the cash value of the command
Lost orders totaling $ 11,996, the average loss is $ 571 per order, or risk ratio was 5.71%. 42 win profitable orders is $ 104,965, won $ 2,499 Per command. Thus, the strategic transaction with a winning ratio average 4.87: 1.
People can look at it and say this strategy was excellent. But that does not speak in the long term it can still profit or not.
Objective No. 1 of the capital account management to survive in the most adverse time. For example, the ratio of win / loss was 4.87 / 1 and the ratio of orders profit / loss à 2/1 looks good in theory, but whether the accounts have survived if he had 21 times consecutive losses, calculated from the first order? The answer is definitely not. I started with a capital of $ 10,000 and $ 11,996 ... lost to accounts made it.
Knowing the longest string of losses in the trading strategy is a plan to survive the most important.
In the example below account
I lost three consecutive orders from 20/8 to 08/09/2014. 3 This command occupy lost $ 2,252, $ 750 Per command. Thus the initial 10k this account can withstand losses and not burnt. Drawdown (maximum loss) is 22:52%.
I lost three consecutive orders from 20/8 to 08/09/2014. 3 This command occupy lost $ 2,252, $ 750 Per command. Thus the initial 10k this account can withstand losses and not burnt. Drawdown (maximum loss) is 22:52%.
This is very important. If my goal is limited to around 50%
drawdown and banana longest losing $ 2.252, I need at least $ 4,504 to
open a trading account. ($ 4504x50% = $ 2,252)
If I did not have $ 4,504 in your account, it may take a higher drawdown rate, 75% instead of 50%, for example. Thus the minimum capital required is $ 3,002 (2252X75%)
On the other hand, if only under the drawdown not be greater than 20%, I would need an initial capital increase corresponding to 11 260 (2,252 * 20%)
So know the longest string of losses can help you visualize the amount of capital needed to overcome stage continuous losses.
Equally important thing next to be able to survive, that's the biggest loss orders occurred during the transaction. In
such accounts, the biggest hole I have ordered $ 2,310 on 18.02.2014,
and of course I've used a similar risk analysis to ensure that the
account is not burnt, but the question is : what would happen if I take
the biggest losses occurred in the longest string of losses, worse if I
suffered the biggest losses 3 orders sequentially. Thus, I am faced with the potential loss is $ 6,930, or 69.3% of risk !!!!
Statistical probability.
I completed 65 years of trading in the order with the longest string of
losses is $ 2,252 and ordered the biggest loss is $ 2,310. So I will be capable of similar losses in the next 65 transactions. If they happen at the same time, the risk observed in the order of 65 to be $ 4,562.
Combining two factors, the potential loss suffered is $ 4,562.
If I accept the drawdown was 50%, the minimum initial capital required to open an account is $ 9,124 (9124 * 50% = $ 4,562)
If approved the drawdown of 75%, the amount needed to open tk is 6,082 $ (6,082 * 75% = $ 4,562)
If only accept drawdown under 20%, they need some cash 22,810 $ (22,810 * 20% = $ 4,562)
Oh, 22k is a large amount, if not enough, why. If so, why not reduce the volume of transactions. Instead of my example above 1 lot, but you just have $ 2,281 to open an account and trading 0.1 lots. Or even just $ 228 if you open 0.01 lot transaction.
In a nutshell, what you need to remember that the analytical accounts are a flexible, and the results will change after each transaction. It is important that you need to analyze continuously to update timely investment performance. Risk ratio, the proportion of profit / loss, proportion win / loss, the longest string of losses, the biggest losses command changes each time completing a transaction, so you must update the data in order to gain benefits most.
This article is not intended to offer a research paper complete risk management. My
purpose is only highlighted what can be done to ensure that your money
is safe maximum, while profits also reached a maximum possible. Trading is a risky business. And we only work with probabilities only. Please pay attention to detail and analyze accounts regularly to ensure you always win probability.
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