How your stop loss placement affects your capital. The difference between success or

upshotsignals

Active Trader
Jun 21, 2011
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First of all, this is not a complete manual on the proper calculations for money management.
That information could probably fill a small book.

What I am going to point out is a particular component of money management that might help you stay out of trouble.

If you are using a certain percentage of your capital when you open a trade, for example 5%.
(We have probably all heard that this is a good percentage to use) you must be aware that if the trade goes against you before becoming profitable, that amount is also additional exposure to your capital.

For example, if we are using a $100,000 account and our trading plan initially includes using a 5% capital exposure on all total trades that are open. This means we would be using approximately $5,000 of capital on all of the trades which will remain open until either they are stopped out or profit targets are achieved.

Another factor that can affect the amount of capital exposure is the type of trading system used.
If we are going to use a swing trading method which requires using a 200 or 300 pip stop loss, this will increase the percentage another 2 or 3% on top of the 5% we used when we initially open the trade.

If you're not prepared to risk 7 or 8% of your account balance on all open trades then I would suggest changing the type of stop loss you are using and the trading system.

If you insist on always using 5% every time you open a trade, my suggestion is to use a trading strategy that is effective but requires a much smaller stop loss.

If however you are limited on time or your personality suits a swing trade methodology, I would reduce the initial risk to perhaps 2 to 3% when the trade is opened.

Another common misunderstanding is when a loss is actually experienced.
If we use the original example of $100,000 and a 5% risk, with a 200 pip stop placement that actually gets hit, we should recalculate the total balance and determine how much we can use on the next trade before opening it.

Sometimes traders continue to use the same lot size or dollar amount even after experiencing a couple of losses in a row. Their thinking is that in order to get back to break even they need to keep using the same amount of money and lot size.

This can be very dangerous and can also lead to more losses much quicker. It's very important to know yourself and the trading system you're using before exposing large amounts of your capital on any given trade.


Good luck trading!
-Irishtrader