Tag Archive for: risk of ruin

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4 Ways to Improve Your Trading

Why do some traders you know seem to profit consistently, while those green trading days elude you? Why do you find yourself consistently making the same mistakes over and over again?

Traders who are successful month in-month out, handle losses in stride. They are comfortable with losing periods, while maintaining discipline. And most certainly, they do not accept under-performance, constantly training to improve their game.

4 ways to improve your trading 2ndskiesforex
The good news is – you can be a successful trader who profits month in-month out.  Nobody is born to be a successful trader. These traits and characteristics can be learned.

Many of my profitable students, were not trained in any related field of finance. Yet they consistently make money.

Trading profitably is certainly possible for you, no matter where you are in your learning curve. But you have to work at it, and likely make a few adjustments from what you are already doing.

Here are 4 ways to drastically improve your forex trading.

1. Maintaining Commitment, Even During Challenging Periods
Throughout your learning curve in forex trading, the actions needed to get you there will not always be fun.

You have to love the process, and enjoy working towards your goals every day, regardless of the daily results.

If you were not being paid to trade, would you still love it, and enjoy the challenge? If so, you will maintain the commitment necessary to succeed.

2. Get Comfortable With Losses, and Losing Periods
How many emails have I received requesting a system with a high win rate? Enough to fill your inbox for a year.

By itself, the win rate does not guarantee profitability. Your risk of ruin does!

But I’m going to make a controversial statement here. That is:

Most un-successful traders who want a high win rate, are really asking for ‘compensation’.

What are they wanting compensation for? A lack of confidence. It is wanting something solid, yet virtually nothing is solid about trading.

Obsessing over a high winning percentage is short sighted. Directing your focus to continually getting better (i.e. on the process), is seeing the forest from the trees.

3. Intentions Must Be Consistent With Actions & Beliefs
If your goals, intentions & efforts in trading haven’t produced consistent results, there is likely one cause. You!

It is one thing to say or think, ‘I want to be a successful & consistent trader‘. But if the moment comes to fill in your trading journal, and you balk, then there is inconsistency between your conscious and unconscious mind.

Just like you may conceptually say ‘I want to be wealthy‘, but if you look around your house, and feel poor, you are not going to create wealth for yourself.

This is called ‘thinking in one way, and feeling another‘. Only when these two (thinking and feeling) come together in your mindset, do you produce results that match your intentions.

successful traders 2ndskiesforex
4. Ban Under-performance in Trading
What is one thing which without fail promotes under-performance? Excuses. Have you ever used excuses for your results in trading? If so, you are making it more probable you will under-perform.

The best way to ban under-performance in trading, is to ban excuses. Adopt a ‘no-excuses‘ approach to trading. Better yet – burn the following mantra in your brain:

I am responsible

You may not be in control of everything that happens in the market, but you are responsible for your performance.

In Closing
Ask yourself, how of the aforementioned forex trading tips and advice suggestions would help you in your trading performance? If you were to adopt the above suggestions, would they change your mindset and approach to trading?

What If Your Trading Plan Cost You Money?

I recently got a daily forex trading plan from a new student and eager beaver who asked for some help with their plan. The moment I opened it, I realized it was incomplete and needed work. To be fair, they had gotten this template from another course, so cannot fault the student.

I generally suggest having two trading plans:

  1. The Day-to-Day Trading Plan which includes your daily procedures
  2. Your Business Trading Plan

What we’ll be focusing on here is related to #1 above. Below is the general outline of their current forex trade plan, which I’ll go over, show you what needs to be changed, and what is missing.

Their Current Trading Plan

  1. Introduction
  2. Price Action Signals to Trade
  3. Rating a Trade
  4. Time Frames
  5. Pairs/Instruments to Trade
  6. Risk-Reward Ratio
  7. # of Positions
  8. Position Sizing
  9. Stop Loss & Take Profit Rules
  10. Rules for Entry
  11. News Events
  12. Documentation
  13. Losing Trades

Do you see anything confusing, missing, or out of place here?

trading plan 2ndskiesforex

 

What I Would Change

#1: Introduction – I think this was a good start. However, two things in this introduction stood out;

a) the opening statement, ‘The goal of this plan is to avoid emotion-based trading‘
b) ‘the trading plan may be adjusted, and the rules edited‘

Lets start with A – If the goal of the trading plan is to ‘avoid emotion based trading‘, the current plan only helps for that day, but doesn’t get at the root cause of ‘emotion based trading‘.

Where should the real work be done for this? Prior to any trading, and in the ‘training’ phase! How? Proper training, building your sub-conscious skill set, and removing limiting beliefs.

For B – this is fine to allow the trading plan to be adjusted, but how often? The trading plan should be an evolving document as your level develops and grows as a trader. But put a time factor to this and stick with it.

I would have in the introduction why I am trading, what I am trying to achieve and what my daily goals are. More on this later.

#2: Price Action Signals to Trade – A military general doesn’t start their plan with tactics. They take all the information in to get a broad picture – i.e. the ‘context‘. In trading, this relates to understanding the price action context first. So this section needs to be later in the plan.

What would I put here? Pre-trading preparation, i.e. how will you prepare for each trading day (physically, mentally, market analysis, etc).

#3: Rating a Trade – We haven’t even gotten to our price action context first. This comes before rating a trade for quality. So this should be done here, starting with our top down analysis, how we find the correct context, then go from here.

NOTE: In this template from the other course, their highest point rating for a trade was ‘big size‘ for the signal bar.

Now let me get this straight – the size of the 1-2 bar pattern, is given the most importance? One bar out of the 30-50+ bars which comprise the validity of the signal?

confusion about trading
Seems like a confusion to me on what price action is about. Yet ‘Trading with the Trend’ is 5th on their list? How does one bar by itself, have greater value than the entire trend and order flow to this point?

Lastly, the 13-pt rating list completely rules out intra-day trading. A trading plan should be flexible enough to incorporate both.

# 4 & 5: Time Frames – by now, we are too far ahead of ourselves with this plan. Once we know the context, only then can we know the tactics (price action strategies) to use. We cover this in more detail with our course members.

One other thing about this is the fallacy that the time frame is more important than the instrument you trade. Should be the other way around.

Pairs/Instruments to Trade – Although this is completely necessary, I think in one section you can have the pairs/time frames you are trading.

# 6, 7 & 8: Risk-Reward Ratio/# of Positions/Position Sizing – The first one is completely irrelevant by itself without understanding the Risk of Ruin.

You can use my risk of ruin calculator to find yours. For more information on the risk of ruin formula, click on the link above.

Number of Positions – kind of irrelevant. Although you may have a fixed % equity risk per trade, what if you start your day, and realize 4-5 high quality setups on deck?

fixed percent equity risk model superior than fixed dollar amount graph 1 2ndskiesforex

My suggestion is to have a max risk per day, and per trade. If your max risk per day is say 5%, and you spot 5 trade setups, then you can risk 1% per trade. If only 2, then you can risk 2.5% per trade. As long as you keep the risk of ruin at zero, the number of positions should not be limited IMO.

Position Sizing – Can all be addressed under one section, which I’d label ‘Risk Management‘

# 9 & 10 & 13: SL & TP Rules/Rules for Entry – should be addressed in the strategy itself.

#11: News Events – I’d say make this part of the ‘pre-trading preparation‘, under the ‘market analysis‘ preparation.

#12: Documentation/Journal – I agree this needs to be part of your forex trade plan. But there is nothing in here about reviewing your trades, or end of the trading week analysis. Monthly, quarterly and yearly reviews would be recommended.

What About Training?

I generally recommend having a completely separate plan for training, very much like professional athletes have practice/training routines, which are separate from game-day preparation. Trading should be no different.

For those trading higher time frames like daily and 4hr strategies, I’d recommend using your non-trading time for practice/training. This is not just demo trading, reading books, or studying course material. We suggest going beyond this with live forward simulation trading, just like fighter pilots do simulators, or baseball players have batting practice.

practicing forex trading 2ndskiesforex

Our favorite tool for this is Forex Tester 2, which allows you to go back in time, and then live forward trade it bar by bar as if they were appearing in real time.

You can get a $50 discount on Forex Tester 2 by clicking here.

In Summary

As you can see, the template they were working with was quite confusing, lacking key things, and out of order. Had I been working off that trading plan and not known better, I would be approaching the market incorrectly every day, missing a dearth of things.

It is important to understand a professional trader will see things on a more sophisticated level than your traditional 1-2 bar pattern trader. Professionals, by default, can recognize opportunities beginning traders will not, like a good poker player can make money on more hands than a weaker one. This also goes for one’s daily forex trading plan, so having a more evolved one will give you a greater edge.

professional traders 2ndskiesforex
Ask yourself, how sophisticated is your trading plan? Does it feel unorganized, confusing and incomplete like the first template? Does it even include pre-trading preparation? What would you recommend adding to this trading plan?

Please make sure to share your answers, along with whether you agree or not, and why you agree/disagree.

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Fixed % Equity vs. Fixed Dollar Amount | Which is Better?

Last year Nathan at winnerstradingedge.com wrote a brilliant piece which you can find here talking about Why Nial Fuller’s Method Doesn’t Work (referring specifically to his risk models).

In this article, he is responding to Nial’s claim that the superior forex risk management system is to risk a fixed dollar amount per trade. It should be noted Nial’s main claims were 1) a fixed dollar amount could get you out of a DD (drawdown) faster when winning, while 2) it would take longer to get out of the same DD if you used a fixed % equity model.

Nathan decides to demonstrate in two scenarios how a fixed % equity model is actually far superior. Nathan’s data shows clearly using a fixed dollar amount actually hurts you both in DDs (drawdowns) and during winning streaks.

I completely disagree with Nial Fuller and have always endorsed a fixed % equity risk model as being far superior. I will demonstrate this later with data and several scenarios. But first, onto Nathan’s results.

In this chart below, he shows two accounts each with the same starting balance of $10000. The two accounts were either using a 2% risk per trade method (representing the fixed % equity model) vs. the fixed dollar amount (risking $200 per trade each trade). Below is the graph showing the performance of the two models.

fixed percent equity risk model superior than fixed dollar amount graph 1 2ndskiesforex

Nathan in his experience noticed how traders go on winning streaks. He thus tested two scenarios, whereby the traders go on either a 10 win-streak, or a 10-loss streak. The green line is our model (fixed equity % model). The red line is Nial’s model (the fixed dollar risk method).

During a winning streak, our fixed % equity model pulls away from Nial’s fixed dollar amount and continues to gain further as it goes on. This happens around trade 5 and continually separates further after each winning trade.

For the losing streak, our fixed % equity model again outperforms Nial’s, by losing less each trade, thus protecting your capital.

After Nathan published this data highlighting the differences, people on both sides disagreed.  But nobody was providing any more data to back up either side. We at 2ndSkiesForex decided to run the numbers ourselves and further demonstrate how a fixed % equity model was far superior.

The first forex risk scenario we looked at was a 10 win trade recovery after the 10 loss series Nathan presented above. Here is how the data plays out below.

 

After 10 losses, Trader A goes on to win the next 10 using the fixed % model:
-As per the chart above, Trader A has a balance of $8171 at trade 10. This continues below-

$8334.42 at trade 11
$8501.10 at trade 12
$8671.12 at trade 13
$8844.54 at trade 14
$9021.43 at trade 15
$9201.85 at trade 16
$9385.88 at trade 17
$9573.99 at trade 18
$9765.06 at trade 19
$9960.36 at trade 20 for fixed 2% rule

 

After After 10 losses, Trader B goes on to win the next 10 using the fixed % model:
-As per the chart above, Trader B has a balance of $8000 at trade 10
-Since the math is easy, at trade 20 Trader B has a balance of $10000, for a whopping .4% difference.

Now in comparing the numbers as a whole over these last three scenarios, lets look at the following three facts:
1) During the first 10 win UD (updraw), you get +1.58% BETTER performance (more upside) using a fixed % model
2) During a 10 loss DD (drawdown), you get +1.71% BETTER performance (or lesser DD) using a fixed % model
3) During the next 10 win UD (updraw) you get -.4% LESSER performance (or lesser gains) using a fixed % model

So in two out of the three forex risk scenarios above, the fixed % equity model outperforms the fixed dollar amount. The total edge is +2.89% over the fixed dollar amount using the fixed % equity method.

But lets take this a few steps further and lay out the other 4 scenarios from here to see which performs better. They are;

Scenario 1 = 10 more straight wins from trade 20

Scenario 2 = 5 more straight wins from trade 20 

Scenario 3 = 5 more straight losses from trade 20

Scenario 4 = 10 more straight losses from trade 20

 

Scenario #1: (10 more straight wins from Trade 20, or T20)
Trader A Balance = $9960.36
Trader B Balance = $10000

After 10 more trades (T21-T30), the fixed 2% model will have a balance of $12143 while the fixed dollar model will have a balance of $12,000. Summed up, the fixed % model has $143 MORE in profit, or a 1.2% GREATER gain. Hence the fixed % model wins this scenario.

 

Scenario #2 (5 more straight wins from trade 20)
Trader A Balance = $9960.36
Trader B Balance = $10000

After T25 (or 5 more straight wins), fixed 2% model has a balance of $10998.69 while the fixed dollar amount has a balance of $11,000, or a whopping $1.31 more, which is only a .01% gain over the fixed % model. Pretty weak difference. But a win nonetheless for the fixed dollar model.

 

Scenario#3: (5 more straight losses from trade 20)
Trader A Balance = $9960.36
Trader B Balance = $10000

By T25, the fixed % model has a balance of $9002.78, while the fixed dollar amount has a balance of $9000. Summed up, the fixed % model has $2.78 MORE in profit, or a .03% gain over the fixed dollar amount. A small difference, but nonetheless a win for the fixed % model.

Obviously from here the answer gets much uglier for the fixed dollar amount model as this progresses, but here are the numbers below.

 

Scenario #4: (10 more straight losses from trade 20)
Trader A Balance = $9960.36
Trader B Balance = $10000

By T30, the fixed % amount has a balance of $8136.84, while the fixed dollar amount has a balance of $8000. So the fixed % model has $136.84 MORE in capital, or a 1.7% gain over the fixed dollar amount.

When you tally up the 2 scenarios by Nathan, plus the 4 we just ran, the score is 5-1 with the fixed % equity model being the far superior model.

Here are the numbers and scenarios summarized below;
Scenario A (Nathan’s scenario – 10 wins from 10k) = +1.58% better performance for fixed % equity model
Scenario B (Nathan’s scenario -10 losses from 10k) = +1.71% better performance for fixed % equity model
Scenario 1 (as per my description above) = +1.2% better performance for fixed % equity model
Scenario 2 (as per my description above) = -.01% worse performance for fixed % equity model
Scenario 3 (as per my description above) = +.03% better performance for fixed % equity model
Scenario 4 (as per my description above) = +1.7% better performance for fixed % equity model

This comes out to a grand total +6.21% better performance for the fixed % equity model across 6 scenarios.

 

Translation

This shows a huge advantage using the fixed % equity forex risk management model which is clearly far superior to the fixed dollar amount method. This is only across 20-30 trades using any one scenario above. The more trades this gets applied to, the better the performance. Over a traders lifetime of 500, 1000, or 5000+ trades, this edge becomes exponentially superior.

Keep in mind, you cannot do any risk of ruin calculations using a fixed dollar amount, however you can using our % equity model. Anyone using Nial’s fixed dollar model is simply throwing money away over time.

This should end the debate between which forex risk management system is the better model. Clearly the fixed % equity forex risk management model wins by a Mortal Kombat Fatality.

I would like to state I am welcome to see evidence to the contrary if/when it is presented, as I am totally open to seeing it.

Make sure to share this “how much to risk per trade” article as it discusses a critical topic for your trading. But more importantly – leave a comment whether you agree or disagree, and why.

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Money Management, Performance & A Secret

Did you know you could have a 50% accuracy ratio for your trading, always have a 2R profit target, and still lose money? Its true, (although its a low probability), but remains true nonetheless. How? Because of two key factors: % account risked and your risk of ruin ratio. At a bare minimum, you have to understand 4 things about your trading to know mathematically if you will make money.

What are those 4 things? That is what this forex money management plan article is going to cover in detail. I will begin by discussing what these 4 things are, and how not knowing them will hurt your account. Then I will describe the risk of ruin formula and why its essential for your trading performance. I will end by sharing a forex money management secret that will impact how you think about money management and risk.

risk and money management 2ndskiesforex

The 4 Things You Need To Know
Any article discussing forex money management plans and performance without discussing risk of ruin is incomplete at best and detrimental to your account at worst

Why?

Because at a bare minimum, you need to know 4 things about your trading to know if you will make money or not. They are the following;

1) Risk to Reward Ratio
2) Accuracy
3) % Risked Per Trade
4) Your Risk of Ruin

Simply put, you could be trading a 1:2 reward to risk ratio, and still lose money. You could know #1 along with your accuracy, and still lose money. You could know your % risked per trade and still lose money. But if you know those three + #4, you can mathematically know whether you will make or lose money.

How?

The Risk of Ruin Formula

What is the Risk of Ruin formula, how does it apply to my trading performance?
The risk of ruin formula is designed to communicate statistically if you will make or lose money trading. You can mathematically know for a fact if you will make, or lose money by knowing your risk of ruin. But you cannot calculate the risk of ruin formula without three key pieces of data. They are:

1) Risk to Reward Ratio
2) Accuracy
3) % Risked Per Trade

Combined together, these above will give you your risk of ruin (ROR). The ROR is a number representing the % chance you will ‘ruin’ your account, e.g. blow it up. Not a pleasant thought, but a highly useful piece of data and essential for your success.

What you want is a 0% ROR (risk of ruin) or a 0% chance of blowing up your account. The inverse of this is you mathematically will make money.

Now remember the first thing I said about how a trader with 50% accuracy always having a 2R reward could still lose money? Let me share why via two risk or ruin tables below.

Trader A Risking 10% of Account Equity ROR Table

Win Ratio % Payoff Ratio 2:1 (2R Profit)
Win Ratio 40% 14.2
Win Ratio 45% 3.41
Win Ratio 50% .813
Win Ratio 55% .187
Win Ratio 60% .0401
Win Ratio 65% 0

Looking at the chart above, by risking 10% of your account equity per trade, having a win ratio of 50% and a payoff ratio of 2:1 (2R per trade), you have a .813% chance of ruining your entire account. Although this is a low probability, it is still a possibility. You actually have to be 65% accurate to mathematically ‘know’ you will make money.

Now lets take the same win and payoff ratios (50% / 2R), reduce the risk per trade to 5% of your total equity, and see how the numbers change.

Trader B Risking 5% of Account Equity ROR Table

Win Ratio % Payoff Ratio 2:1 (2R Profit)
Win Ratio 40% 2.03
Win Ratio 45% .116
Win Ratio 50% 0
Win Ratio 55% 0
Win Ratio 60% 0
Win Ratio 65% 0

In this second table, only those with a 40-45% accuracy have a mathematical chance of losing money. But those at 50% accuracy have a zero % chance of losing money, thus mathematically will make money. What is the key difference? The % risked per trade. This is why it is absolutely critical to your money management strategy to use a % equity risk model, not a meaningless ‘dollar risked per trade’.

Also notice how risking 5% per trade instead of 10% drastically changed the accuracy levels needed to make money? Trader A needed a 65% accuracy level to be certain they could make money, while Trader B only needed a 50% accuracy level – a 10% difference!

It should also communicate an essential point;
Any forex money management strategy article or website talking about trading without mentioning the above, is giving you totally incomplete information about money management which could kill your account. In essence, you could be trading blind to the numbers which hugely determine your success or failure in trading.

A critical piece of information? Absolutely. Something you’d want to know? I’d certainly hope so.

trading insight 2ndskiesforex

One Last Point (A Secret About Money Management)
There is one thing almost never talked about when discussing trading money management strategies. It is a huge point why working with a % equity model is far superior to ‘dollar risked per trade’. And it has to do with your mind.

If you are setting the risk per trade based on a ‘dollar value’, that dollar value actually means more to your mind (and thus emotions) than an ‘neutral’ % of your account. Why? Because you spend money in terms of dollars (or euros, or whatever your local currency is), not %’s of your account.

So if you are making a trade, and thinking ‘Oh, I’m going to risk $5,000 on this trade‘, that very thought of ‘$5,000’ can (and most likely will) conjure up a host thoughts about rent, bills, car payments, or a wave of other things.

These thoughts are far more likely to engage any fears you have about the ‘dollars you are risking per trade‘ than a neutral 1 or 2% which has ‘no reference‘ to how much you spend, may need, or what it could buy.  In essence, there is no ‘trigger‘ in your mind about % risked per trade, but there certainly is about the ‘dollars risked per trade.’

By shifting your trading money management strategy and trading mindset towards a % equity model, your mind will be more focused on the actual trade. This is opposed to dealing with the thoughts ‘Oh, that $5,000 is a lot of money to me. I’m about to risk $5,000 which could pay for my rent, my mortgage, or my debts‘.

This mind trick actually helps to reduce the emotional triggers when trading, thus leaving your cognitive mind less burdened with thoughts of the money, and more focused on the trade. This is a huge reason why a % equity model is far superior from a trading mindset perspective than a ‘dollar risked per trade’ model.  Food for thought, but I hope this clarifies the huge advantages and information available when thinking about forex money management in terms of a % equity of your account.

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Forex Trading, Ted Williams, & The Little Details Pt. 2

Last week I talked about the importance of looking at the details and refining one’s trading game in Forex Trading, Ted Williams, & The Little Details Pt. 1 article. All highly skilled professionals realize paying attention to the details pays dividends, and often leads to the difference between being good and great. Today is the continuation of that article, where I will be sharing how making a small trading adjustment in my trading could lead to a six-figure change in profits per year.
But before I get into one small adjustment I need to make in my personal trading, I want to discuss a few amazing examples of how Ted Williams really paid attention to the details, and how these small things separated him from the rest.
ted williams forex trading and the little details 2ndskiestrading.com
 
Attention to Details
Ted was known to be obsessive about his hitting skills and had made several adjustments which allowed him to understand hitting better than most of his time. Here are some of the details below;
-He traditionally used a much lighter bat than most of the heavy hitters (sluggers) back in the day. To test how sensitive he was to the lightness of the bats, he was once presented with 4 bats, 3 weighing 34 ounces, and one weighing 33.5 ounces. Most people on the planet now could not tell the difference between 34 and 33.5 ounces, a .5 oz difference, or to put this in context, a 1.4% difference in the weight of the bat (.5oz / 34 = .014, or 1.4%).
Yet Ted was able to consistently tell the difference and identify the lighter bat each time.
-Ted used to warn his teammates to avoid leaving their bats on the ground. Since the bats were made of wood, this would cause them to absorb the moisture in the dirt or grass, and thus become heavier, which would slow their swing down. How would he have known this unless he was sensitive to all the details?
-After he retired, in a Sports Illustrated article, he was able to demonstrate how swinging at a pitch, just one baseball width outside the strike zone heavily affected his batting average, and he divided the strike zone into 77 baseballs, with each baseball being = to a particular batting average for each pitch in that location.
When reading the above examples of how Ted paid attention to the details, you can see why he was such a great hitter and baseball player. All of those small little details, while they may seem insignificant on their own, led to a huge difference between him and everyone else.
paying attention to details in trading 2ndskiestrading.com
 
Paying Attention to Details in Trading
This is exactly the same for trading. Did you know using the risk of ruin tables, if you were 35% accurate, risking 2% per trade, and always taking profits at 2x your risk, you would have an 8.37% chance of blowing up your account?
But reduce your risk to 1% per trade, and the chance of you blowing up your account is only .7%, which is improving your chances of being profitable 119x?
That is quite a huge difference, all with one small detail.
SIDE NOTE: This is also the reason why we always measure risk in % terms, not in dollars terms. Professionals don’t measure risk in terms of dollars, they do it in terms of %’s, because this is where they can use the risk of ruin and math to guide them about trading performance as dollars are relative to you.
 
The One Details Which = A Six Figure Difference
I was reviewing my trading journal one day in March this year, and noticed a behavior continually repeating itself. I had been making sure to mark in my journal since 2012, every time I entered at market, but also noting  if I was entering a bit early in relationship to the system entry. I marked it with the code EM (‘entered at market’) / HOP (‘hit original price’).
Several weeks ago, I noticed this happening several times in the same week, so I started to go back through my entire trading journal over the last 12 mos to see how many times this happened. The answer….
78% of all trades entered at market, would have executed at the original price the system gave the entry at. This occurred a total of 242x in the last 12 months.
3.6 Pips
I decided to compile a few more stats to really get into the details and see what kind of effect this was having on my trading.
The average entry was 3.6 pips less than my system entry price.
Now 3.6 pips may not seem like a lot, but it has a significant effect on your trading.  To give an example, lets say you have the following trade setup with my system giving me the stop and take profit (limit) levels using the following data below;
Long EURUSD at 1.3003 (entered 3 pips early at market)
Target = 1.3103 (100 pips)
Stop = 1.2953 (50 pips)
Total reward to risk ratio is 2:1
But lets adjust this by just 3 pips, meaning I entered at 1.3000, still had the stop at the same level (1.2953) and target (1.3003) assuming they were my targets based on the original price action system numbers.
This translates into the stop being 47 pips, and the target being 103 pips, or a 6 pip difference. This also increases the reward to risk ratio from 2:1, to 2.2:1, or a 10% difference just in the R:R ratios.
This 3 pip earlier entry, was in reality a 6 pip difference, but for me, the number was 3.6 pips, so a total of 7.2 pips of difference in performance.  Assuming a 50% win ratio, 7.2 pips x 242 EM/HOP (entered at market/hit original price) would result in a 1742.4 pips difference.  Based on the average lot size, this would = ~200K USD.  Even if we halve this performance, it would still be ~100K USD, which is a huge difference in performance, per year!
forex trading combing through performance details 2ndskiestrading.com
The Difference Between…
After getting over the initial shock of how much of a difference this small detail meant in my performance, I have come to a greater understanding of how important the small details are in trading and performance (in anything). Often times, these small details can be the difference between losing and winning, between breaking even and making money, between being just good or great.
Thus, make sure to apply a fine comb to your trading account performance and journal, to mine the little details which could be separating you from losing and winning, or making a little money to a lot. You cannot underestimate the power and difference a few small pips, or one small bad habit can have on your trading.
All highly skilled professionals pay attention to these small details, as they can truly create a world of difference in performance. Jimmy Hendrix realized this when adjusting his guitars. Ted Williams also realized this when it came to baseball and batting.
The question then remains, will you take the time to find the little details which could be holding you back? How much is it worth to you, to take a few hours away from the screen time, the beach, or the bars drinking, so you can increase your performance by a huge amount? The benefits could last you a lifetime, and it’s possible this could be one of the best reward-to-risk plays you ever embark on.

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Forex Trading, Ted Williams, & the Little Details Pt. 1

With liquidity dying down heading into the Easter holiday coming this Sunday, instead of writing my evening price action market commentary article, I wanted to write a little two part series today and tomorrow about some of the overlooked aspects of trading – the little details.
Wasn’t Ted Williams a baseball player?
Yes he was – and a great one at that.
This lesson actually centers around a great story about Ted, although not during his trading career, but well after it had ended.
ted williams 1941 forex trading and the little details 2ndskiestrading.com
Several years ago, the Ted Williams museum was collecting several items from Ted’s great career to be stored in the museum for all to appreciate. For those that don’t know much about Ted, he is considered to be one of the greatest hitters of all time, and in 1941, he hit a .406 average – which makes him the last person in over 70 years to finish a season above .400.
Williams was known to pay attention to the details of everything he did when it came to baseball, especially hitting. His famous bat  during the 1941 season was suspected to have been bought initially by a collector for over $20,000. When the museum had bought the bat, they had asked Ted to come to the museum and verify if it was his bat.
He saw the bat, closed his eyes, and put his hands firmly around the handle just as he held the bat to hit a baseball.
After a short pause, he said the following;
“Yep, this is one of my bats for sure.”
One of the members at the museum had asked him how he had known it was his bat.
He responded;
“Back in the years 1940 and 1941, I had cut a groove in the handle of my bats to rest my right index finger in. I can still feel the groove in this bat here.”
You will find amongst some of the greatest concert pianists, guitarists, athletes, and anyone highly skilled in their craft, they pay attention to the details and the smallest aspects of their game. Often times, these small details and steps will lead to a large result, often times separating success from failure, breaking even to profitability, and from just good to great.
Ted Williams realized that if he could rest his index finger more naturally into the bat, it would influence his swing. That is attention to detail.
Jimmy Hendrix would adjust and oversee every guitar he ever used. Anytime he got a new guitar, he would bend the ‘tremolo‘ (whammy bar) by hand for hours at a time.
Why?
By bending it and getting it closer to the body, he could tap the strings while raising and lowering the pitch, sometimes down three steps instead of one.
That is attention to detail, and just one in the dozens he did when adjusting his guitar.
jimi hendrix forex trading and the little details 2ndskiestrading.com
All highly skilled professionals look towards the details as a way to refine their game. And this is something you have to do in your forex trading. You have have to constantly refine your trading to greater and greater levels of precision, detail and performance. Maybe you have to adjust your equity threshold, or maybe you have to adjust your engulfing bar entry, as the vanilla one is quite inefficient.
As Michael Jordan once said;
” Take small steps. Don’t let anything trip you up in reaching your goal. All of those small steps are like little pieces of a puzzle. Eventually they come together to form a picture of greatness. But doing things step by step – I cannot see any other way of accomplishing anything.”
putting pieces of the puzzle together 2ndskiestrading.com
So take some time to think of all the little details where you could refine your trading. We all have them, regardless of our level, profitability, or account size. I’m willing to bet that if you look at the numbers, and run the data on your performance, perhaps even adjusting your risk of ruin, if you just changed one little detail, you would be completely amazed at how it would affect your performance.
This can make the difference between being profitable and losing money, between barely breaking even and consistently profiting, or the difference between being good or great. Ask yourself where you are on that spectrum, and where you’d like to be. Then get to work.
Keep in mind, I’ve never met a single profitable trader who cut shortcuts, who tried the easy way out, who wanted something for free, or was willing to steal to get there. Food for thought…but without having the mindset of abundance, how can you expect to be a professional trader who works with bigger and bigger amounts of money?
Tomorrow before the weekend, I’ll write the second part of this article, where I share one piece of data I’ve recently discovered in my personal trading, that would be the difference between my current performance, and a six-figure car…per year…without compounding.
See you then…

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Trading & Thinking in Probabilities

The A+ Setups, The Trades That ‘Kick You In The Chin’

There is one mistake I see beginning traders constantly making. They wait on the sidelines for days, waiting for A+ setups, waiting for setups that ‘kick them in the chin‘, or ‘knock them over the head‘.

If you need to get kicked in the chin or knocked over the head to act, perhaps you should consider MMA, not trading. If you need this to actually do something – you really are missing the most basic thing of being a successful trader.

Your job is not to sit there like Johnny Bench waiting for the delivery of the perfect pitch.  Your job is to think in probabilities, to think in numbers and expectancy.  This is one advantage for becoming a better trader by learning how to play poker.

poker playing probabilities trading 2ndskiestrading.com

 
Positive Expectancy
In poker, they have this rule about positive expectancy.  It basically involves not waiting for your power hands to arrive before you play. You should [pay your medium strength hands in the right environment because they have positive expectancy.
Sure, you can wait for AA or AK suited before you get involved in the pot, but you are passing up many hands that make money in the long term.  You are passing up hands that have positive expectancy.   This doctrine about waiting for A+ setups is a fallacy espoused by people who really do not understand trading. It is important to remember trading is not a fashion contest.
Trading is thinking in probabilities and finding setups that make money over 100, 1,000 or 10,000x.
You have to understand, that you may not make money on the trade right now, or even the next one, but if it makes money over the long run (has positive expectancy) then you need to pull the trigger.
professional forex trading thinking in probabilities 2ndskiestrading.com
 
Beginning Traders vs. Professional Traders
Beginning traders make the mistake of waiting for setups which have 60 or 70+% accuracy, trading at 1:1 or 2:1 reward to risk ratios. Sure…mathematically these will make money, but guess what – did you know you could have a system which is 35% accurate which still makes money (and a lot of it) over time?
Although losing 65 trades out of 100 may seem daunting, a professional trader doesn’t skip these trades – because they know they make money.  This is the difference between a beginning trader and a professional – they think in probabilities.  They are comfortable with uncertainty, because they trust the process.
 
Breaking It Down
To look at it mathematically, if you take 100 trades at 35% accuracy, you win 35 and lose 65.  Now if you always target 3x your risk (meaning if you risk 50 pips, you target 150 pips each time), this system will make money. Although you may lose the next 6-7 trades, all you need to do is win 3 or more, and you’ll make money over those 10 trades.
This is the difference between a professional & beginning trader. They understand the risk of ruin principle, and are not worried whether they will win the next trade. Beginning traders rationalize losing the next 6-7 trades as being bad for their overall trading, when mathematically you can still make money.
 
What Separates Beginning Traders from Professional Traders
Professional traders are not worried about the next trade winning or losing. What they care about is making money long term and over time.  They want to maximize their profits by playing the mathematics – by thinking in probabilities.

professional forex trading chris capre 2ndskiestrading.com

Although beginning traders hang their entire psychology, confidence and performance on the next trade – you have to look at the next one as just one free throw in the thousands you will make over time.
 
A Single Grain of Sand & Your Positive Sloping Equity Curve
One way to relate to an individual trade is to see how really unimportant one trade is in the grand scheme of things.  A good visual for this is – if you are currently holding a hand full of sand you picked up from the beach – that each trade is like a single grain of sand.
If you are using proper risk management and thinking in probabilities, that one grain of sand is really insignificant. Put them all together, and it adds up to something more substantial, but by itself, it really means very little.
Now imagine your positive upward sloping equity curve over the next few years, with hundreds of trades per year under your belt. That one grain of sand really means nothing in the entire equity curve of profitability.  It’s just a tiny data point in a very large set.

profitable equity curve professional forex trading 2ndskiestrading.com
After a Long Trading Career

If you can really grasp this, I guarantee after you have a long trading history with hundreds (if not thousands) of trades under your belt, one little trade will not mean anything to you.  But what will matter, is if you pass up trades that have positive expectancy with lesser accuracy, you may lose massive profits over time.

Thus make sure to let go of whether the next trade will be a winner or a loser.  Try not to invest too much energy in this.  Start to think like a professional, and pull the trigger whether your next setup has high or low accuracy.  If your price action strategy has positive expectancy, then that is what you need to know.  When you do, you’ll realize a huge piece of the missing puzzle as you’ve started to think like a professional, and started to think in probabilities.

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3 Ways Archery Helps My Trading

Last week was the first time I had gone back to my archery school in over a year.   Approximately 2mins into the class, I realized how much I had missed formal archery classes, but also how archery helps my trading.

Now I am not suggesting you need to grab an Olympic bow and start taking archery classes to take your trading to the next level.  But, it often helps to acquire a second skill or practice to assist your main endeavor – i.e. trading.
For example, Joe Namath was constantly reminded by his coaches he needed to work on his footwork.  So he did what every quarterback does…he took up dancing!  Footwork was critical to his position, and dancing helped him improve his footwork dramatically.
In almost all skill based endeavors, an additional practice can really improve one’s core skill.  I’m going to share with you three ways Archery helps my trading.
 
1) Focus on the Complete Process
In archery, to hit the target consistently, you have to repeat a specific motion with the precision of a Swiss watch.  But to do this, you have to be completely present and focused on the moment and process.
I had developed a habit of pulling my back shoulder towards my head.  As my teacher corrected me on this, my concentration naturally became more focused on my pulling shoulder.  But, in the process, I wasn’t rotating my front elbow properly.
I quickly realized too much concentration on one area meant less on another.  Now just imagine if I was a tightrope walker and had this problem 😮
tightrope walking 2ndskiestrading.com
I find this to be the same with developing traders – they focus too much on strategy (particularly the system and entry) but not enough on controlling risk.  Managing risk is a game of pure mathematics, and with most traders, they take profits too early, but get hit for their full stops.
 
Does this sound familiar?
This is a mathematical disaster waiting to happen, and unless you understand your risk of ruin tables, along with how your system performs over time, you may be 60% accurate or better, but mathematically doomed to lose money.
To be a successful trader, you have to focus on the complete process and every aspect of trading.  This means just as much attention to proper risk management, building a successful trading psychology, AND a winning system.  If any one is lacking, you will unlikely make money over time.
 
2) It’s All In the Mind
My last session before returning home was the advanced practice focused solely on shooting at longer distances.  Normally, I train at 18m, but for this class it was at 30m.
Obviously, some adjustments had to be made, like changing the sight, getting used to holding the bow higher, etc.
After a few rounds, I was shooting close (but not quite) to what I normally would at 18m.
At the very end though, things got interesting.
We ended by shooting three rounds back at 18m, and it ‘felt‘ incredibly easier.  Yes, precision becomes more critical at longer distances, but it also felt easier as a whole.  Something changed in my mind, and I definitely felt more confident about shooting at 18m.
But what I noticed is with the top shooters in the school, they almost shot identical to what they did at 18m. Why were they able to shoot the same at 18m as they did at 30m?
The difference was in the mind.  To them, their mind was just as focused on the task at 12m as it was at 30m, and they were also just as confident.  That difference in the ‘thinking it was harder’ for me, definitely translated into my experience of it, particularly my confidence.
brain working 2ndskiestrading.com
Just like archery, so much of trading is in what goes on between your two ears.  Take a look at your last 20-30 losing trades in your journal, and see how many of them are related to mental errors, as opposed to you executing everything perfectly, but the trade just not working out?
Now do the math and see what you would have done if you had executed the strategy perfectly.  Try the same for your last 20-30 wins, particularly the ones whereby you exited too early, and do the math again. Take a look at the results, and I’m willing to be with over 90% of you, your performance would have improved (if not been highly profitable) if you had used the strategy according to its rules.
Numbers are the best sirens for traders, so see the financial impact your mind has on your results.  Now imagine that every month for the next 5 years and see what the difference would be.  You are likely talking about two different trading careers.
So ask yourself how many errors do you make simply because of your mind & emotions, then see what you can do to make less errors.  For traders more often than not – it’s in the mind.
 
3) Repetition is Key
Nobody will become a professional golfer swinging the club only 5-7x a month.  The same goes for throwing a baseball, playing piano, and trading as well.  There is no way you are going to really understand trading, patterns, price action, or the markets if you are only pulling the trigger less than 7x a month.
If you are currently doing this, you are not getting enough feedback from the market, and almost certainly not finding good setups, because there are plenty that happen per day.
beijing olympic archer 2ndskiestrading.com
Just like in archery, repetition is key to getting the process and technique down.  This does not mean you will become a better archer shooting an arrow every 10 seconds as opposed to every 20.  There has to be deliberate practice and you have to be able to concentrate on each trade, just like each arrow.
Thus, repeating the process more often will generally lead to better development, so make sure you are trading every day unless there is absolutely no signal with your system.  But if that is the case, consider getting another system.  Trading is like a feedback loop which communicates information on you, what you see in the markets, and how you are doing.  Any lack of feedback usually means a missed opportunity to both profit and learning more about yourself and where you need to develop.
 
In Summary
Often times, when learning any skill based endeavor (like trading), finding another practice to engage in will often help augment your development as a trader.  Many things come to mind, such as playing chess, learning an instrument, training in a brain gym, playing poker :-), and also archery.  All of them have aspects which develop key skills highly useful for trading, and could provide the necessary tools to take your trading to the next level.
In terms of trading though, make sure to realize how a lot of it is in the mind (confidence, emotions, etc), to focus on the complete process (risk management, trading psychology, strategy), and how repetition helps develop your skills as a trader.

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The Risk of Ruin Tables You Should Know

Many people will talk about their forex Risk-Reward ratios such as it’s important to have 2:1, 3:1, or whatever to one ratio, but this is just the tip of the iceberg of risk-management and leaves you uninformed and un-empowered.  You can actually have a 3:1 Reward-Risk ratio and lose all the money in your account.  You can also have a 1:1 Reward-Risk ratio and make money day in day out.

2ndSkies Forex Tip of the Iceberg Chris Capre

How can you understand the difference between the two?  Through the Risk-of-Ruin formula.

We did a 1hr webinar on Risk Management, the Risk of Ruin formulas and how critical they are, whether you are trading Price Action Strategies, Ichimoku Kinko Hyo, or any other system.

I got many requests for the information contained in the Risk of Ruin formulas so I am posting all the tables here so you can see the mathematics of your trading and whether you have the numbers in your favor.  Here they are below:

 

Risk of Ruin Formula using 10% Risk / Trade

ROR% with 10 capital at risk
Win Ratio %   Payoff Ratio 1:1   PR 2:1   PR 3:1   PR 4:1    PR 5:1
Win Ratio 10%    100 100 100 100 100
Win Ratio 15%    100 100 100 100 100
Win Ratio 20%    100 100 100 100 46.6
Win Ratio 25%    100 100 100 30.5 16.3
Win Ratio 30%    100 100 27.7 10.2 6.1
Win Ratio 35%    100 60.9 8.2 3.53 2.33
Win Ratio 40%    100 14.2 2.5 1.24 0.888
Win Ratio 45%    100 3.41 0.761 0.426 0.329
Win Ratio 50%    100 0.813 0.226 0.141 0.116
Win Ratio 55%    13.4 0.187 0.0635 0.0438 0
Win Ratio 60%    1.73 0.0401 0 0 0
Win Ratio 65%    0.205 0 0 0 0
Win Ratio 70%    0 0 0 0 0
Win Ratio 75%    0 0 0 0 0
Win Ratio 80%    0 0 0 0 0
Win Ratio 85%    0 0 0 0 0
Win Ratio 90%    0 0 0 0 0

 

Risk of Ruin Formula using 5% Risk / Trade

ROR% with 5 capital at risk
Win Ratio %   Payoff Ratio 1:1   PR 2:1   PR 3:1   PR 4:1    PR 5:1
Win Ratio 10%    100 100 100 100 100
Win Ratio 15%    100 100 100 100 100
Win Ratio 20%    100 100 100 100 21.7
Win Ratio 25%    100 100 100 9.33 2.67
Win Ratio 30%    100 100 7.67 1.03 0.372
Win Ratio 35%    100 37.1 0.672 0.124 0.0544
Win Ratio 40%    100 2.03 0.0623 0 0
Win Ratio 45%    100 0.116 0 0 0
Win Ratio 50%    100 0 0 0 0
Win Ratio 55%    1.81 0 0 0 0
Win Ratio 60%    0 0 0 0 0
Win Ratio 65%    0 0 0 0 0
Win Ratio 70%    0 0 0 0 0
Win Ratio 75%    0 0 0 0 0
Win Ratio 80%    0 0 0 0 0
Win Ratio 85%    0 0 0 0 0
Win Ratio 90%    0 0 0 0 0

 

Risk of Ruin Formula using 2% Risk / Trade

ROR% with 2 capital at risk
Win Ratio %   Payoff Ratio 1:1   PR 2:1   PR 3:1   PR 4:1    PR 5:1
Win Ratio 10%    100 100 100 100 100
Win Ratio 15%    100 100 100 100 100
Win Ratio 20%    100 100 100 100 2.2
Win Ratio 25%    100 100 100 0.266 0
Win Ratio 30%    100 100 0.163 0 0
Win Ratio 35%    100 8.37 0 0 0
Win Ratio 40%    100 0 0 0 0
Win Ratio 45%    100 0 0 0 0
Win Ratio 50%    100 0 0 0 0
Win Ratio 55%    0 0 0 0 0
Win Ratio 60%    0 0 0 0 0
Win Ratio 65%    0 0 0 0 0
Win Ratio 70%    0 0 0 0 0
Win Ratio 75%    0 0 0 0 0
Win Ratio 80%    0 0 0 0 0
Win Ratio 85%    0 0 0 0 0
Win Ratio 90%    0 0 0 0 0

 

Risk of Ruin Formula using 1% Risk / Trade

ROR% with 1 capital at risk
Win Ratio %   Payoff Ratio 1:1   PR 2:1   PR 3:1   PR 4:1    PR 5:1
Win Ratio 10%    100 100 100 100 100
Win Ratio 15%    100 100 100 100 100
Win Ratio 20%    100 100 100 100 0.0485
Win Ratio 25%    100 100 100 0 0
Win Ratio 30%    100 100 0 0 0
Win Ratio 35%    100 0.701 0 0 0
Win Ratio 40%    100 0 0 0 0
Win Ratio 45%    100 0 0 0 0
Win Ratio 50%    100 0 0 0 0
Win Ratio 55%    0 0 0 0 0
Win Ratio 60%    0 0 0 0 0
Win Ratio 65%    0 0 0 0 0
Win Ratio 70%    0 0 0 0 0
Win Ratio 75%    0 0 0 0 0
Win Ratio 80%    0 0 0 0 0
Win Ratio 85%    0 0 0 0 0
Win Ratio 90%    0 0 0 0 0

 

Hopefully after viewing the Risk of Ruin tables and underlying forex trading risk mathematics, you will begin to look at your trading differently, analyze whether you have the mathematics in your favor to make money day in day out, or are setup to lose money. Understanding the mathematics of risk can make all the difference in the world so make sure you study these numbers in relation to trading your rule-based system.

We have a Risk of Ruin Calculator available here, for your convenience.

Remember to leave us your comments which are always appreciated, and also to click the ‘Like’ and ‘Tweet’ buttons below to share it.

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Money Management and the Risk of Ruin

I have been getting a lot of comments, questions and emails about money management trading strategies as of late, with the market becoming very volatile.

This article will show you the most important math you will need to learn to have a long term money management strategy in place, which will put the mathematics in your favor.

Risk of Ruin

The Risk of Ruin is a statistical model which tells you the chances you will lose all of your account based upon your win/loss % and how much risk you put per trade.  This is absolutely critical to know.

Case in point, lets say you are risking 10% of your capital per trade, and say have a 2:1 Reward to Risk Ratio or R:R, and have an accuracy rate of say 35%.  Did you know you have a 60.8% chance you will lose all of your money?

Is this something you would want to know ahead of time?  Lets hope so.

But first, we need to talk about its history and how we can adapt it to trading.

History of the Risk of Ruin Model

The mathematics of the Risk of Ruin tables were first applied to gambling.

In gambling, say blackjack, if you win a hand with the dealer busting, you get a 1-1 payout so if you put $100 on the hand, you will win $100.  It helps to know this ahead of time so you can see if your edge (% chance you will win over time) is enough to make money or lose money.

However, here is the tricky part. In trading, we rarely know exactly how much we are going to make per trade. 

We have a limit and a stop (hopefully) right off the bat so we are aware of our risk and potential profit.  But here is the harbinger and some questions to consider;

  1. How many times have you actually closed a winning trade before hitting your full profit target?
  2. Do you have a trading system where the profit target is exactly the same (fixed amount of pips) and therefore you know what your exact payout will be if you hit the target?
  3. Do you know exactly how accurate you are going to be with your trading based on the system you use?  In other words, have you modeled it so you can predict its overall accuracy within a few % each month?

If the answer to question 1 is around 25% or greater, then we will need to take this into serious consideration when calculating our risk of ruin.

If the answer to question 2 is no, then you will need to favor this in when calculating your risk of ruin.

If the answer to question 3 is no, then the answer is the same as above and its likely the mathematics are working completely against you.

Lets explore each question, then the math and then see what is a stable level of risk so you can keep your account growing.

Closing a Winning Trade Before Hitting Full Target

For those of you that are still learning how to trade consistently, be honest and ask a critical question:

How many times have you closed a winning trade before hitting the full target? 

If what I hear from people learning how to trade is representative, the answer is likely “many”.

If you were perfect in your discipline and never made an error in trading and risk management, then I would say go ahead and risk 10% of your capital every time, if you could always trade with 40% accuracy and had a reward to risk ratio of 2:1.

If you did this, you would have only a 14.3% chance of losing all your capital and likely have a winning account.

However, if you cut your profit targets for whatever reason – say 50% of the time and you cut them in half, then with the same level of accuracy, your risk of ruin goes up to about 60%.

Meaning you have a 60% chance of losing all your capital.

This changes the game completely, and puts the mathematics heavily against you having a long trading career.

In fact, every time you shorten your original profit target, you stack the numbers against you.

Now ask yourself what is more likely…that you a) are shortening your profit targets or b) increasing them?

If you are shortening them, this means you have to decrease the amount of risk per trade to keep the same mathematical edge.

A trading system where the profit target is fixed every time (say 50pips)

How many of you are using this as your only method to trade the markets?

My guess is the answer is likely less than 10%, as most of you are probably not using just one system to trade the market, but several.  Even if you were using one system, the chances are it does not have a fixed target.

The reason why having a fixed target gives you an edge (mathematically), is once you can stabilize the accuracy ratio, you can easily calculate your risk of ruin because your risk and reward are fixed from the outset.  This makes the math very tidy.

However, having a fixed target may not always be advisable.  Sometimes the market will go for a runner, so it helps to take advantage of those big moves when they come.

They increase the alpha (the rate of return on an instrument in excess of what would be predicted by an equilibrium model) on your returns, and help smooth out losing periods.  For a full article on alpha, click here.

To give you a different picture, if your system is on average 50% accurate, your R:R ratios are 2:1, you should be making $1000 on every win and $500 on every loss.

After 10 trades you will have banked $2,500.  However, if you have an alpha of 5%, you will make an extra $125 which over time adds up.

Regardless, if your system does not have a fixed profit target in pips, then you will want to reduce your risk % based upon keeping the mathematics more in your favor.

How Accurate Are You Going To Be?


Unless you have done massive forward and backtesting on your system, you will unlikely know the answer to this question.

On top of this, markets change and your accuracy levels will likely change with them.  A question to ask yourself is;

Do you even know your current accuracy ratio for all your trades? Per Pair? Per System? 

If you do not, then it is highly likely you will have the numbers stacked against you, and your chance of losing all your capital is more likely than you assume.

What this means is to be on the safe side, you will want to have a smaller amount of % equity at risk per trade.  This also becomes more critical in the early stages of your trading where you are likely to make more mistakes, have a lower equity ratio and take profit before hitting your full target.

Now that we have gone over this, lets take a look at a table below using the Risk of Ruin formula.
risk_of_ruin = ((1 – Edge)/(1 + Edge)) ^ Capital_Units

ROR % with 10% capital at risk Payoff Ratio 1:1 PR 2:1 PR 3:1 PR 4:1 PR 5:1
Win Ratio 25% 100% 100% 99% 30.30% 16.20%
WR 30% 100% 100% 27.70% 10.20% 6.00%
WR 35% 100% 60.80% 8.20% 3.60% 2.30%
WR 40% 100% 14.30% 2.50% 1.30% 0.80%
WR 45% 100% 3.30% 0.80% 0.40% 0.30%
WR 50% 99% 0.80% 0.20% 0.10% 0.10%
WR 55% 13.20% 0.20% 0.10% 0.10% 0.00%
WR 60% 1.70% 0.00% 0.00% 0.00% 0.00%
WR 65% 0% 0.00% 0.00% 0.00% 0.00%
WR 75% 0% 0.00% 0.00% 0.00% 0.00%
WR 80% 0% 0.00% 0.00% 0.00% 0.00%

Lets deconstruct this briefly.

Using 10% of capital at risk per trade, if you are 35% accurate and have an R:R ratio of 2:1, you have a 60.8% chance of losing all your capital.

However, if you can increase your edge (accuracy) by 5%, you only have a 14.3% chance of losing your entire account.  This shows the power of increasing accuracy ratio to gain a greater edge.

Now, lets take the same accuracy ratio of 35% but increase the R:R to 3:1 from 2:1.

What this does is turn your 60.8% risk of ruin to 8.2% so in actuality, this gives you a tremendous edge.

Here is the challenge; in trading, it is actually harder to increase the profit target from 2:1 to 3:1 than it is to increase your accuracy ratio of 5%.

An increase of 5% in accuracy is not a big shift.  10-20% is a big shift and much harder to achieve.  Over 100 trades, you only have to win 5 more or 1 in 20 more.

But to increase your profit target from say 100 pips to 150 becomes much harder, simply because you are trying to capture more of the days range.

This requires more precision in your entry, all to increase your bottom line edge by 6% from 14.30 risk of ruin to 8.2% risk of ruin.  And if you are not hitting your full targets to begin with, does making your profit target larger seem more reasonable?  Unlikely.

Now lets take the other side of this equation.

Lets say you are 35% accurate (not too demanding a figure) and have a 3:1 R:R. You will only have an 8.2% chance of losing all your capital. 

However, if you are like virtually everyone else learning how to trade and you take profits early, say 50% of the time, how does this change the mathematics?

It turns your Risk of Ruin from 8.2% to 34%.  So now you have a 3 in 10 chance of losing all your capital.  Not bad but definitely less stable.  This is assuming you are perfect in taking profits at 3:1 R:R 50% of the time and 50% at 2:1 R:R.

However, things happen and make it very difficult for us to be not only perfect in our discipline, but also perfect in our mathematics and R:R ratios.

It is simple if we are trading blackjack where we know the fixed profits we can make and lose. However, this is not blackjack – it is a fluid living breathing market and sometimes it would be advisable to exit early.

Does this increase your edge or reduce it?

More than likely, any adjustments to the system and R:R ratios decrease your edge, not increase them.

So what does this mean for you?

Risk less than 10% of your capital per trade.  Risk a lot less.  Put the edge so far in your favor that it is almost inconceivable you would lose all your capital.

If you have capital, you are in the game. If you don’t, you are out. Your capital is your ammo and without it, your dead in this game. 

Especially when learning how to trade consistently, keep your risk low – like 2%.

Even when you are really good, keep it low because you will have losing periods and when you do, you want to absorb them well and not take big chunks out of your account.  Risking 10% will do this but risking 2% will not.

Although it may not seem like you will make a lot of money risking 2% and having a 2:1 R:R, over time as your account grows, it will compound and you will take losses with ease of stride.

However, by risking 5-10%, you severely alter the mathematics and your edge.  And far worse, you increase the psychological pressure to recover the losses and that actually compounds the emotional/mental energies against you.

As long as your R:R ratio is 2:1 or better, when you lose you will lose a little and when you win you win much more.  Even if you take a series of losses, it will only take just as many wins to be back ahead.

Case in point; say you have a 10k account and have a 2:1 R:R and risk 2% per trade.  Here is how the math works out below after a series of 3 losers and 3 winners:

10k with 1 loss at 2% = $200 loss and acct is at $9,800
$9,800 with 2nd loss at 2% = $196 loss and acct is at $9,604
$9,604 with 3rd loss at 2% = $192.08 and acct is at $9,411.92

So you lost 3 trades in a row and now win 3 trades, here is the tally:

$9,411.92 with 1st win at 4% gain (2:1 R:R ratio) = $376.47 and acct is at $9,788.39
$9,788.39 with 2nd win at 4% gain = $391.53 and acct is at $10,179.92
*thus after 2 trades you are back into profit.
$10,179.92 with 3rd win at 4% gain = $407.19 and acct is at $10,587.11

So even after two wins, you erased 3 losses and with the 3rd win you are way ahead.

Thus, hopefully you can see the importance of having a good R:R while having low risk.

It is psychologically hard to deal with big losses, but little losses have a much smaller impact on your emotions and trading, so keeping an edge both mathematically and psychologically is crucial to winning at this game.

For another great article on money management trading strategies, make sure to check out Your Equity Threshold and the Psychology of Money