Page 39 - Trading #101 Course – PART II TWO: SUCCESSFUL TRADING PIE – www.traderscoach.com

TRADING #101 COURSE – PART II TWO: SUCCESSFUL TRADING PIE – WWW.TRADERSCOACH.COM

3. Percent of capital exposed to trading. A general ball park rule of thumb is that
you risk no more than 2 percent of your trading account value on any one trade.
You can determine the optimal, or more exact percent of capital to risk either by
referring to the risk of ruin tables or by using the optimal f formula in this chapter.
More advanced traders may at times decide to risk more than 2 percent, so this
amount will probably vary and change as your performance ratios change.

Your trading system design governs the first two items in the risk of ruin formula (win
ratio and payoff ratio), and your money management system controls the third item
(percent of capital exposed).

The risk of ruin decreases as the payoff ratio increases or the probability of winning
increases. The larger the percent of capital risked on each trade, the higher the chances
for risk of ruin.
So, if your known quantity is your win ratio and your payoff ratio, then the variable, or
unknown quantity, is going to be the percent of capital that you decide to expose when
trading.

Will it be 1 percent, 2 percent, or 3 percent?

Or will the percent you select to put at risk be a custom number that will change as your
trading results change?

For our purposes, we are assuming that you already have a system that gives you an
edge and provides you with a payoff ratio that is better than 1 to 1. You can estimate
what your risk of ruin is by identifying what your payoff ratio and win ratio are and by
referring to the risk of ruin tables in this chapter from Tables 11.1 to 11.8.

It is quite revealing to see how your probabilities in these tables can go from 100
percent likely chance of ruin to 0.0 percent.

With a little planning and thought you can dramatically increase your odds of success
just by having respect for the ROR formula. You do not need to be a mathematical
genius, and you don’t need to know how to do the calculations yourself; just understand
the principles and the impact your risk choices make.

It’s as simple as adjusting the percent of your capital you put at risk—either lower
or higher, depending on your current performance statistics.

These calculations (risk of ruin) assume that your payoff ratio and win ratio are a
constant. In practice, these numbers will keep changing over time, and any estimates
you have today will probably change in a few months. We must always keep in mind
that the past does not predict the future.

Thus, it is better to constantly monitor your current win and payoff ratios to adjust the
percentage of risk you take with every new trade. Determining how to analyze this data
in and of itself can be a part of your personal money management plan.

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