This part is one of the most important you will ever read about trading. Why is it so important? Well, our goal is to make money, so that we have managed to make money, we must learn how to manage it. Ironically, this is one of the areas in the trade that usually anticipate. Many traders are just anxious to get right into trading regardless of account size.
They simply determine how much they stand to lose in a single trade and hit the button traded. There’s a term for this type of investment called gambling. When you trade without money management. Instead you are just looking for that “jackpot”. Money management rules will not only protect, but will make us very profitable in the long run. If you do not believe me and you think that “gambling” is the way that a man is rich, then consider the following example:
People go to gamble in the hope of winning big grand prize and in fact, many of them succeed in this. Then how casinos around the world and continue to earn, if we have a lot of winning jackpots? The answer is that in the long run, even though people win jackpots, casino is profitable because they rake in more money from people who do not win. Hence the name ‘house always wins’ (the house always wins). Even if an XY person has won $1 million on a slot machine, the casinos know that day will be more than 1,000 gamblers who do not win the jackpot and the money will go directly into their pockets. You will have the opportunity to become profitable. You want to be rich statistician not the gambler because in the long run, you want to always be a winner. So, how to become rich statistician instead of a loser?
1% risk rule for a €100.000 trading account
making a long stock trade with an entry price of €75, and a stop loss price of €70, would be calculated:
Maximum Capital = €100.000 / 100 = €1,000
Trade Size = €1.000 / ((€75 – €70) x 1) = 200 shares
If the trade makes a loss (by trading at its stop loss price), the 200 shares will lose €5 each.
Total loss of €1.000 and it is 1% of the trading account.
1% risk rule for a €30.000 trading account is making a short futures trade on a market with a €10 point value, with an entry price of €4,125, and a stop loss price of €4.150, would be calculated as follows:
Maximum Capital = €30.000 / 100 = €300
Trade Size = €300 / ((€4.125 – €4.150) x 10) = 1 contract (actually 1.2 contracts, but this is not possible)
If the trade makes a loss (by trading at its stop loss price), the one contract will lose €250 (which is less than 1% of the trading account).
If you open an account with $300 and use 200:1 leverage to open mini lot trades of $10.000 dollars and double your money in one trade.
Nothing could be further from the truth.
Not everyone has $5.000 to open an account using larger lots with a small account balance.
An investor deposits $10,000. The account is set to 0.5% margin or 200:1 Leverage.
This means that for every 5,000 lot opened, the investor must maintain at least $25 in Margin (= $5,000 x 0.5%).
He bought of USD 100.000 (20 lots at $5.000) and the selling of CHF 101.500 (= $100.000 x 1.0150) by using $500 as a Margin (= $100.000 x 0.5%) and borrowing USD 99.500 from broker (= $100.000-$500)
The investor decided to take his profit and enters a sell market order in the broker trading platform.
Investor sold of USD 100.000 (20 lots at $5.000) and the buying of CHF 103.000 (= $100.000 x 1.0300).
Leverage is 1:100, Margin is 1% EUR/USD rate is 1.3600), 1 lot of standard contract of EUR/USD = € 100,000.00 Euro. We have to multiply the Contract size in dollars. Therefore 1 lot of EUR/USD = 136,000.00
As Margin is 1% of the Base Currency. 100 x Dollar
Client have to have a minimum of $1, 3600.00 in order to be able to buy/sell this position
Client wants to open a 4 mini contacts (40,000base currency) = 0.4 Lots.
At the rate of GBP/USD = 1.6300 (£ 40,000.00 = $65,200.00) 1/100 * $65,200 = $652.
Client has to have a minimum of $652 in order to be able to buy/sell this position.
Current price of West Texas Intermediate crude oil was quoted as U.S. Oil $ 46.00
You bought 1 lot (100 barrels) at a price of $ 46.00
The value of trades x Price x factor margin (percentage).
100 (a barrel) x $ 46.00 x 0.01 = $ 46.00
The smallest increase in oil prices is 0.01.
The smallest trade that can be done is one lot (100 barrels).
At this level, each pip is worth $1.
When changing prices from $46.00 to $46.30 the difference was 0.30 (30 pip).
If you trade 1 lot, each pip is worth $ 1, your profit or loss will be $30.
Leverage = 1/Margin = 100/Margin Percentage
A 200:1 ratio yields 1/200 = 0.005 = 0.5%.
If the margin is 0.01, then the margin percentage is 1%, and leverage = 1/0.01 = 100/1 = 100.
Margin Requirement = Current Price x Units Traded x Margin
Buy 1000 Euros (EUR) with a current price of 1.08 USD, and your broker requires a 1% margin.
Required Margin = 1000 x 1.08 x 0.01 = $10.80 USD.
The advantage of trading on margin is that you can make a high percentage of gain compared to your account balance. It has a $1000 account balance it isn’t traded on margin. It initiates a $1000 trade that nets you 100 pips. In a $1.000 trade, each pip is worth 10 cents.
The profit from its trade would be $10 or a 1% gain. It was to use that same $1000 to make a 50 to 1 margin. Trade is giving it a trade value of $50.000 the same 100 pips would net you $500 or a 50% gain. It is still using a $1000 account balance. It initiates a $1000 trade and loose 100 pips. It lost is only $10 or 1%. If it was to make a 50 to 1 margin trade for $50000 a loss of 100 pips takes $500 or 50% of capital. One more trade like that and account is finished. In the first example it only lost $10 or 1%. It could make that same losing trade 99 more times before the account was empty. If you open an account with $300 and use 200:1 leverage to open mini lot trades of $10.000 dollars and double your money in one trade. The best rule of thumb is to be as conservative as you can. Not everyone has $5.000 to open an account with. If you are trading on a 50 to 1 margin, then for every $1 in your account, you are able to trade $50 in a trade.
Overloading account the reality that will happen at some point. The less you risk per trade, the less will be your maximum overload. The more you lose in your account, tends to be back in the positive. Trade only with a small percentage of your account, because the smaller the better. Recommended load your account is 3% or even less. It is desirable to trade when you have a high ratio between profit and risk. The higher the ratio, you are entitled to more errors. Another way that you can increase your chances of profitability is to trade when you have a potential to earn eg. 3 times more than the risk. If you give the benefit to risk 3:1, you have a much greater ability to finish in the black in the long run. In this example you can see that even if you get only 50% of trading and you will still earn $ 10,000. Just remember that whenever you trade with a good risk-return profile, the chances of being profitable are much greater, even if a lower percentage of profitable trading.
Money Management
You have a total of 10 transactions. 5 of profitable and 5 lost transactions. 5 of profitable transactions with $ 3,000 and the remaining five are from a lost $ 1,000.
5x $ 3,000 = $ 15,000 profit
5x $ 1,000 = $ 5,000 loss
Result = profit-loss
Result = $ 15000- $ 5000 = $ 10000
You have a $ 100,000 and you lose $ 50,000. What percentage of account you have lost? Simply, the answer is 50%. Now, what percentage of that $ 50,000 you have to earn in order to return to your original $ 100,000? Not 50% – now you have to make 100% of your $ 50,000 to go to the beginning! In trading are always looking for an edge. This is why traders develop systems. Commercial system that is cost-effective in 70% of cases, sounds like a very good thing. However, if the trading system is 70% profitable, does that mean you will every 100 trading get 7 out of every 10?