I have a slide, which I showed at the London Studio, showing two traders making identical trades. One put on the same size trade irrespective of the stop size and the other put on less the looser the stop was thereby keeping the amount of trading capital at risk constant.
The latter strategy prevents the risk getting bigger than intended:
risk = stop * lot
lot = risk / stop
For each trade, first calculate the percentage capital at risk (eg 1%) and then divide this by the size of the stop in points:
So using a reward:risk ratio of 60:40 makes the losses smaller than the wins. Can I lose even more and still breakeven? Imagine a trading system where you could be wrong 70% of the time and not lose money!
Well here we could focus on those trades that are initially profitable but then go to the stop. We cannot take the initial, small profit because we don't know if it would have subsequently gone to our profit target. And snatching profits early is not good for a long and prosperous career in trading.
We could however have a stop that follows price: if the initial stop was at -40 and price went to +10, this would move the stop to -30. Trailing stops like this further reduce the size of the stop. Not all losing trades reach +10 first, so getting to 70:30 is unlikely with this method but certainly the risk will be reduced to somewhere between 30 and 40.
Is it possible to make losses smaller without making wins smaller as well? Not with a coin flipping system, but with forex we can make the stop tighter than the limit. Remember I am only aiming for breakeven with the risk management. If I elected to have a 40 point stop and a 60 profit target, I could lose 60% of the time and still breakeven:
Try to imagine a risk management system where breakeven whatever the outcome. In trading, we are dealing with a binomial system. When we enter a trade the outcome is unknown but we do know there are two possible outcomes - win or lose.
I put together a business case for day trading foreign currency using FXMM Grids. My starting point with FX trading is risk management. Success in the markets is defined by ones ability to manage risk.
At data releases, brokers protect themselves from speculators by widening their spreads. The move from tight spread to wide spread does NOT involve quoting prices between the new spread. In other words, temporarily, there is no market between the widened spread.
This is bad news if your stop is between the spread because it will not get filled. You will have to get out manually when there is a market and this could mean being many points beyond where you wanted your stop to be.
My broker horror story: one of my brokers became increasingly keen to protect itself from speculators on NFP day. Initially it would widen the spreads 5 minutes before release. Then 10 minutes and so on. This was both for market and stop/limit orders.
I used to straddle the market with a buy order above and a sell order below (about 20 pips away from market). I made a lot of money doing this. One Friday, my short was triggered but wasn't filled until the market had fallen another 40 points.
I desperately tried to buy the position back, as it whipsawed north, but price gapped up through my stop which wasn't triggered. Price kept going north with my frantically pressing 'buy' but there weren't any takers. I finally got out 60 pips above my stop.