In this episode of Truth About FX, Walter answers a classic question: how much risk should I have on every trade? He shares important key points to keep in mind when deciding this. He also touches on building confidence and easy steps that you should take when testing systems…
And, when is the best time to buy a forex tester?
Download (Duration: 08:29 / 9.71 MB)
In This Episode:
00:36 – classic question
02:44 – take off
04:13 – aggressive risk
06:01 – the best time
07:36 – real kicker
Announcer: Sometimes, forex trading is a wild and wooly place to be. That’s why Hugh is here, to post your questions to Walter, the naked forex guy. Hugh’s got questions and Walter’s got the answers. Here at the Truth About FX Podcast.
Hugh: Hi, Walter. How is it going?
Walter: Great, Hugh. Great to be back! How are you?
Hugh: Pretty good. Getting back to the swing of things. So, this question is, how much should I risk on every trade?
I guess this is the classic question that everybody asks when they’re getting started.
Walter: Yeah, right. Well, like most things in life, it depends. Here’s the thing, there’s a couple of things to keep in mind. Number one is you will stop trading because of the drawdowns that you experience.
Believe it or not, that is completely under your control. By adjusting the amount that you risk on every trade, assuming of course that you’re using a model where you risk a certain set percentage per trade, set percentage on every trade.
I’ll put in the shownotes, I’ll link up the calculator so that you can go through and calculate this out on your own. If you know what your average winner is, what your average loser is, and what your win rate is, you can determine the likelihood that you’ll reach a drawdown of x%.
Let’s say that you do not want to have a 25% drawdown. Then, knowing your win rate, your average winner and your average loser, you can work this out. That is one thing to keep in mind.
Most people will stop trading because they’ve risked too much and they’ve hit a drawdown that they just can’t stomach. They’ll say things like, “Oh! The market has changed” or “my system does not work anymore, I’m freaking out.” And then, they’ll go and find something else. That’s the number one thing.
Number two is, what is your goal? What is your goal is the kind of question that I was talking about before when we’re talking about drawdown, which is what your goal should be and what your call is may not be aligned.
What your goal should be is to avoid a drawdown that is going to make you freak out because that is why most traders stop trading their particular system. It is because they freak out.
You can backwards engineer that and figure out the amount at risk per trade to avoid that. The other thing is what if you are the kind of guy that says, “Look, let’s say that you’ve got an 80 grand that you’re trading and let’s say that you’ve set aside 2 grand and you just really want to inflate that up.”
You really want to take that and just push it to the limits. You can use something like the “Optimal F from Ralph Vince” — I will link up his books in the shownotes — which is called the “Safe F”. Which is kind of a take off from Ralph Vince’s thing where it’s less aggressive.
What you’re doing is you’re risking a set amount without trying and avoiding certain drawdowns so it’s a different take. Optimal F is basically this. It’s the amount that you should risk on every trade to maximize the returns on that account.
The problem with the Optimal F, the reason why people talked about it, is because it can also blow up your account. That’s understandable. Why would we talk about something that maximize return on your account? Because you might end with the 99% drawdown or something like that.
That’s is why it’s the Safe F. It’s all kind of luck or the drawdown whether or not your particular case when you’re running the Optimal F if you get so many losers that you… It’s essentially, it’s almost impossible to get out of that.
Now, you could still have an 80% drawdown. Let’s say that you take $2,000 and you’ve worked it up to 200 grand because you are trading Optimal F or something to get rid of that.
Well, you’ve got 200 grand and let’s say that you have 80% drawdown. That means you would from 2,000 to 200 grand, you had an 80% drawdown so, now what are you down? You are down to 40 grand.
You’re still gone from 200 to 40 grand but you’ve lost 160. Those are the sorts of moves, those wild swings that are probably going to happen if you risk a lot per trade. It doesn’t mean you shouldn’t do it but for most traders, they are going to freak out.
Now, it’s a different thing if you take a really small percentage to your account and you apply some sort of aggressive risk management system such as Optimal F. That is a different story and then you are more conservative with the rest.
A lot of people do that. That can be a successful way to do it but I just want to keep in mind here that when you asked how much I risk on every trade, it really depended on your system. What your win rate is, what your average winner, average loser. What kind of drawdown you are trying to avoid so you do not freak out and quit trading and also what your goals are.
Is it to have a nice, smooth equity curve without a lot of really crazy drawdowns? Or, is it to like, just completely inflate the account as fast as possible? In which case, you’re probably going to be using some sort of thing like Optimal F.
That is basically my answer for that. I am wondering what your thoughts are on that, Hugh.
Hugh: Yeah. I know I totally agree on that but I have a follow up question for that. Let’s say that somebody is just totally brand new and first of all, natural inclination is going to be to jump into a live account and start trading, right?
But, as we both know, we should test the system and figure out if it has any potential or not. When somebody is just starting out like that, what should they start risking, do you think, when they’re testing a system?
Walter: Great question. Basically, what I recommend and what I like to do is to run it through. You want it through a lot of hoops — and we’ve talked about this before. So I would say number one, forex tester, triple your money.
Number two, demo account, triple your money. Number three, small money account, triple your money. Number four, move up to a bigger account — this doesn’t have to be a full size account. So, really you do not want to jump in with live money.
I was just talking to a trader today, I said, “Hey, do you have forex tester?” And the trader said, “No, I don’t. I’m just getting new into this stuff and just figuring it out”. I said, “Hey, that is really a good time to buy forex tester.”
Hugh: It’s the best time.
Walter: Yeah, it’s the best time. You won’t believe your timing here. His excuse is like, “Well, I’m just getting started. I don’t have money to get forex tester.” I’m like, “Well, if you are just getting started, forex tester is pretty much like the best investment that you can make.” or something like that. It doesn’t have to be forex tester but you know what I mean, a simulator.
To answer your question, what I would say is baby steps. The way you build your confidence is by getting experience and if you do not have experience trading because you are a newbie, you can get experience in forex tester. You can get experience in demo trading.
That’s what I would say and I know I keep hammering it on this but what you are trying to do, neurologically, is you are trying to make… You’re trying to pull the excitement out of it. You are trying to deaden your senses so that when you are taking trades, you’re not getting excited and elated when things go well.
It’s always great when you have win streak and it always sucks when you have a losing streak but the thing is by having experience, you can take the long view and you can go, “I don’t care that my last 3 or 4 trades are a loser. I am going to look at my trades in terms of 30 trades chunks.”
You’ll only get there when you have experience taking a lot of trades. My whole thing is if you are a newbie, you need to take a lot of trades. The best way to do that is to take trades that aren’t going to lose your money, which means forex tester and demo account. Then, go ahead and move it to a smaller account where you’re actually losing pennies and things like that.
That is fine. It’s just that you want to get to the point where you don’t want to change what you do based on what happened during the last trade. That’s the real kicker. Thing that ruins us traders is when we change everything because of what happened during the last trade.
That’s it, you’ve got to take the long point. It’s a sort of like, “I’m going to look at my trades. I’m going to analyze them and see what’s going on, pick everything but I’ve got to do that in 30 or 50 trade chunks not in just one trade chunks” So, that’s what I would say about that.
I hope that makes sense to the listeners.
Hugh: Okay, cool. Thanks for that. That’s great advice and forex tester — the best time to buy is right when you start.
Walter: Yeah, we both agree on that.