Money Management

As an example to get you thinking in the right way, let's say you only risk 1% of your capital per trade with say, ten CFD trades, with the (unhappy) result of you losing the ten trades—then you have lost just 10% of your trading capital. You get the picture of how quickly your capital would be wiped out if you traded a higher percentage of your capital?

THE 80/20 RULE

Let’s say you have your head screwed on and you have done your homework and you manage to get five of the ten trades as winners and five as losers. So that’s now a 5% loss. Out of the five winning trades, in reality, one or two will break-even and one or two will make a bit of money, but its normally one or two that will trend well (if your method allows winners to run) so basically you will make your profit out of one or two trades, so you will make 80% of your profit out of 20% of your trades.

I hope this points out the importance of handling money.

And sometimes it’s not actually the trading method that’s important, it’s actually the money management. In fact money management is one of the few topics professional traders agree on as super important.

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- Calculate Position Size

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CFD Portfolio Trading Topics

It may shock and surprise you then, to learn that this is not correct at all. In such a game scenario, literally every player saw different results, even though they all had the exact same set of trades. How can this be? The answer is “position sizing.”

Think about it for a moment. The trades themselves are only part of the equation. In order to achieve the exact same results, every trader would have to have purchased the same number of shares in each of those trades, which obviously did not occur. Note here, that it doesn’t matter if one player’s base of resources is larger than another’s (ie – it doesn’t matter if you have a million dollars to invest, and I only have ten thousand, because we’re looking at position sizing as a percentage of our respective accounts, and our returns, as a percentage as well, so we can compare our results “apples to apples,” even if we’re investing very different sums of money. True, your ten percent return will yield more dollars than mine will, but from a percentage POV, we have performed at the same level.

Position Sizing then, is one of the most important keys to CFD trading. Knowing how much to buy of each trade, and how much to risk, long or short. Remember, the core principle here is to minimize your risks and let your profits run. The keys to minimizing your risk is to understand your R-multiples, ( R means Risk)have a solid exit strategy in mind for every single trade you enter into (and stick with it once you set it!), and to properly “size” each trade you make. A good rule of thumb here (and the one recommended by the Trading Lounge) is to risk no more than 1% of your total account value on any given trade.

Another truism that applies here is the “80/20” principle. In terms of investing, what this means is that in practice, about 80% of your total returns will be generated from 20% of your trades. Think about that for just a moment.

These are the trades that actually add to your net worth and increase the value of your trading account. Note the phrase “performed beyond your expectations.” The key word there is “expectations,” and this brings to the fore the final consideration. Your “Expectancy Rate,” which we’ve talked about before. If you’re serious about trading, then you need to know this value.

So what does all of this have to do with the CFD Portfolio? Everything, because our newly launched tool is a dashboard style view that puts all of this information, and more, at your fingertips. Using this tool, you can easily ensure that you always get your position sizing right, for each and every trade you undertake, in addition to tracking all the variables that are critical to your long term success.

Consider the CFD Portfolio to be your secret weapon. It’s the thing that will have you trading like a seasoned pro, even if you’re just starting out. We’re proud to offer it to all of our members, and we know that it will serve you well. At the same time though, this IS a new tool, and we welcome any feedback you might have about it that will help us improve not only its usability and user friendliness, but also to provide you ever more information and greater insights into your trading positions.

Now, if you’re new to trading, I already know what you’re thinking. Expectancy doesn’t really matter because you’re already keeping statistics, and you surely don’t need any more, right? After all, you’re tracking your win/loss ratio, and as long as you’re winning more than you’re losing, you should be good to go!

The formula you want to be using is this:

EXPECTANCY = (Average Gain x Win %) – (Average Loss x Loss %)

Look at the components of this formula and you’ll begin to see why it’s so important. Your win/loss ratio is in the equation, but it’s only a part of the overall picture. For example, you might have an outstanding win/loss ratio, but still lose money. How is this possible, you ask?

Some notes and observations on this point. First, you have to understand that you won’t be able to start tracking your Expectancy Rate right from the start. Most experts agree that you need a minimum of thirty or forty trades under your belt before you can start getting anything useful from this measure, and preferably, you’ll want to have a hundred or more trades. The more trades you have to pull data from, the more accurate and reliable this measure becomes.

At the end of the day, what this value really says to you is this: “On any given day, considering my past trading history, I can expect to increase or decrease the value of my trading fund by $X.” Assuming your win % is higher than your loss %, you can expect then, that on most days, you’ll meet or exceed the dollar value revealed by your Expectancy Rate.

Of course, this is merely an average, and unless your loss % is zero (not really possible), there WILL BE some days where you don’t meet your Expectancy.

That’s okay. That’s not a sign that there’s anything wrong, it’s just simply the nature of statistics. By definition, given that this is an average, there are going to be days when your earnings fall below this value.

The other thing to take note of is this: When you begin tracking this value, you may find that your Expectancy is negative. If this is the case, then it should sound alarm bells in your head, and you should suspend your trading activities until you’ve had a chance to overhaul your trading system and parameters, because clearly, something has gone wrong. If you continue to trade under these circumstances, you’re resigning yourself to losing money more days than you’re making money, and obviously, this is not a viable path to long term success. That too, is okay though, because trading doesn’t happen in a vacuum. By tracking these statistics and identifying that there is a problem, you can take steps to correct for it, then try again with a new (and hopefully improved!) system.

As you have no doubt begun to see and understand, there’s a lot more to trading than merely doing your due diligence on a given company, buying stock and waiting to see what happens. Yes, you can trade like that, but you won’t be around in the longer term if you do. Any system you design that relies on hunches or luck is doomed to fail in the longer term. What you need (in addition to careful research before investing in any given company) is a trading plan and system, an exit strategy for every trade, and an understanding of your performance metrics like win/loss ratio and Expectancy. If you’re willing to commit to those things, then odds are excellent that you’ll see your net worth steadily increasing.

Trading isn’t rocket science, but there IS a method to it.

Ignore that methodology at your peril!

That can work in the short run. Sometimes. It’s entirely possible that you have keen instincts and can get lucky, but sooner or later, your luck will turn. Relying on “luck” is simply not a viable trading strategy.

The worst part about relying on your “instincts” and not having a plan though, is the fact that it teaches you bad habits that will prove to be very hard to break later. Learning the dangers of luck, or hunch-based investing can be a hugely expensive education, and cost you untold thousands of dollars.

You can avoid that completely by learning how professional investors view trading opportunities, and mimicking that behavior until it becomes second nature for you. The reality is that you are firmly in control of the risk you are willing to undertake. Let’s call your risk R, for the sake of simplicity, and we’ll measure your risk in 1R increments.

To explain that, let’s say you’re interested in buying stock in a company whose share price is $10. Right up front, you make the decision that should the stock price fall to $8, you will immediately sell. You won’t hold it and hope it recovers.

At any point, if it hits $8 (your risk threshold), you sell. Period. In this case, your 1R is $2. That is to say, if you buy a single share of this stock, the total amount of money you’re spending is $10 (the share price of the stock), but the total amount of money you’re actually risking (1R) is $2.

Of course, odds are excellent that you’re not going to buy “just” a single share of stock, but you can still measure your risk in terms of 1R. So let’s say, for example, that you decide to buy 100 shares of this stock. The money required to do so would be $10 x 100 = ($1000) – (NOTE: for the sake of simplicity here, we’re assuming no brokerage fees or leveraging, both of which would slightly complicate the formula.) But with a firm decision to sell if the stock price drops to $8, the total money you’re actually risking is $2 (which is the 1R value) x 100, or $200.

See the difference in thinking here? For most people new to investing, a $1000 stock investment means that they’re risking all $1000. For you, however, because you have a firm exit strategy, you mitigate (and vastly reduce) your risk. The most you’ll ever lose on this trade is $200. That’s a game-changing, paradigm-shifting way of thinking!

R-Multiples (Risk-Multiples) are simply an expression of profit or loss, using 1R as a baseline.

Your 1R is $2, but your losses are$10-4 = $6). It takes three “1R’s” to make $6, so your loss is 3R. Your loss is expressed as a multiple of the 1R you originally intended to risk. Needless to say, this situation is one you NEVER want to be in.

Let’s look at the other side of the coin though. You buy a stock at $10. Make the firm decision to sell if it drops to $8 (so 1R = $2). But the stock price rises to $40. If you sell at this point, you make a hefty $30 profit, which sounds nice, but don’t look at your profit in those terms. Instead, look at it terms of your R-Multiple. So if 1R=$2, and when you sell, you make a $30 profit, then what you’ve really done is made a 15R profit, right? That is to say, you’ve made fifteen times the money you were originally risking. Obviously, this is a happy situation to be in, and one that you want to find yourself in as often as you can when trading.

The point of all this is that you need to start now, retraining your brain. You need to:

a) be sure you have a plan and an exit strategy for every trade you undertake, and

b) you absolutely need to STOP thinking in terms of raw dollar profit and loss per trade, focusing instead on your risk (1R), and Risk-Multiple, defining your profits and losses in terms of R-Multiples.

Doing this will allow you to view your risk and reward in a whole new way. The way the pros do it, and that’s huge.

It is so important to be organised within a daily routine. I place all the trades that I can ‘short’ from a CFD provider into one watch list and all the ‘long’ trades into another watch list. This way, if I know the markets are going to be in a particular direction for the day, then I can quickly flick through all the stocks already in that list, as I want the focus on finding the best possible trade for that direction — the strongest for long trades and the weakest for short trades. I use our TradingLevels Charting Program for this, (free to download) as I can toggle through each stock quickly. Using a CFD providers’ platform takes too long to go through this processI will only look at each chart for a second or so then flick to the next chart making a note of any good set ups to research further.

For technical analysis I use the TradingLevels, Elliott Wave and Volume. I sometimes use cycle tools for longer term trades. Once I have listed my most promising looking trades I then like to look closer at the ‘Trade Set-up’ as I have to get the entry and the stop right for the ‘Trade Signal’. The entry and stop come from a technical point of view.

Because I encourage my CFD trading members to only risk 1% of their total capital per trade, the entry and stop are important because the closer the stop and entry are to each other the more CFDs you can buy and the further the stop is away from the entry price the less you can buy, as the 1% is a fixed capital amount. If the trade is triggered my first aim is to move the stop to lessen the initial risk amount.

On average I will place 2-3 trades a day, depending if the market is trending or consolidating.

Here are two trader scenarios:

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