March 4, 2010
“Could you give me your comments and suggestion on risk management. What is your position on the rule that many traders have, that at one given point you should not risk more than 1-2% of your total account value. Let say if I have a $10,000 account, I should not risk more than $100-$200 in a trade. And what about placing orders on correlated pairs like the USD/CHF and EUR/USD at the same time if the conditions on the wave, support and resistance are good?”
To 2% or not to 2%. This is a great question. One that I think a lot of traders have. I think risk management is more of a psychological issue. I think that following a stop loss has everything to do with discipline and little to nothing to do with a percentage or number of pips. Based on my opinion, most traders do not follow their “formula” based stop losses because they frankly don’t mean anything. it’s easy to move the placement or ignore it when there is not meaning attached to why the stop loss was placed at a particular price point. Using a 30 pips based stop? Why not 35? It’s just to easy to move when they are arbitrary or based on a number or percent. This is taken from years and years of self observation and teaching hundreds of students up close…
I also don’t like the idea because it somehow insinuates that trading is like gambling or craps…which in some ways I acknowledge it is…but I believe there is less left to change when trading. Friends of mine who are great traders and gamblers succeed because of discipline and knowing when to vary their bet size. That’s not luck or a formula, that comes from identifying when the momentum is on your side!
Now, contrast that to determining a stop loss…there’s a approach there. It’s one that involves the idea that every trade has a point at which it is invalid. The point of validity is the point at which is buy or sell is no longer a trade worth holding because something has changed great enough in price to change the reasoning for the entry. Notice I did not mention a % or # (of pips).
Now, I agree the 1 or 2% can be a threshold. Certainly there are entries that when considering where the point of validity is, could represent too great a risk (potential loss) to your account and those trades should not be taken.
Somehow though 1 to 2% percent morphed from a “threshold” to a “stop loss”. I think that is incorrect. I think that when a triangle breaks, 1 to 2% can be considered as the threshold but that the stop loss is determined by the point of validity (POV). The POV in this case would be the other side of the triangle pattern. How could a triangle breakout through resistance still be valid if prices break down through the uptrend line support…it can’t…and that’s why for this set up, the opposite side of the trade is the validity.
The other side of the triangle is not a percentage or pip consideration, it’s support and resistance. If this POV represents 1 to 2% of your account size then sure, it’s likely the trade presents too much risk. In other words, different trades will be appropriate for some accounts and not appropriate for others.
As to the second question. I don’t have a problem with being long the EUR/USD and short the USD/CHF simultaneously. Each entry must have it’s own set up because merely being long one does not justify being short the other in my opinion. And from the way the question was phrased, I would say you got that.
This also brings up a great point: harmony or synergy. I look for trades — when taking positions across different pairs — to have harmony in regards to their price movement. For example, when the U.S. Dollar rallies it should usually push the EUR/USD lower and the USD/CHF higher. I typically don’t want to hedge and I don’t want to take entries on the same time frame on different pairs that would require — for example — conflicting U.S. Dollar Index movement.
*Note: In volatile market conditions, orders may not be filled as placed and substantial losses may occur.Trading in the off exchange retail foreign currency market is one of the riskiest forms of investment available in the financial markets and suitable for sophisticated individuals and institutions. The possibility exists that you could sustain a substantial loss of funds and therefore you should not invest money that you cannot afford to lose. Nothing in this blogpost is a recommendation to buy or sell currencies.