Trading is all about risk

I’ve been trading long enough to know that it’s not about how much you win
but how much you lose that makes you successful in this business. You will
never be able to control how high a stock, future, or option rises but there
is one thing you can control – your risk. Therefore my favorite strategy deals
with money and risk management rather than buy and sell signals.

There are a number of valid ways in which to determine proper risk and stop
placement but my favorite method uses your system’s worst-case drawdown to
decide your share or contract size which is at the core of risk management.
Lets say you’ve performed 10 years worth of research on your new e-mini S&P
strategy and the profit numbers are quite impressive. Yet what we really need
to know at this point is the value of your systems worse slump or drawdown.
Let’s assume your worst-case drawdown for the 10-year period was a series of
losses that totaled 30 points on the e-mini S&P. With each point on the e-mini
equaling $50, that represents a -$1500 loss "per contract" traded (30 x —50 =

Now let’s assume that you have a total account size of $50,000. What we want
to do is decide on a percentage of your account that you would feel
“comfortable” risking, should your system happen to produce another worst-case
scenario of -30 points in the future. If you decide on risking 10% of your
capital, you are theoretically saying that, should my system go into another
-30-point slump, I will only lose $5000 or 10% of my account. Now divide that
figure by the total dollar loss amount (-$1500) and you arrive at 3.333. This
number, rounded off to 3, is the amount of contracts you can trade on your new
system without getting yourself into any serious damage. This formula can be
applied to equity trading as well.

This ability to control risk is of tremendous benefit because proper knowledge
and use of risk management will ultimately yield much better trading results
than focusing primarily on profits, which is the mistake most beginning
trader/investors often make.

Good luck and good trading.

Steven Primo