Computing optimal risk.....The ESSENTIAL formula

The Amateur versus the Pro trader.

Amateur traders and beginners rarely consider the importance of optimal trade size and instead tend to risk all or most of their capital on one large trade instead of placing a large number of trades in different markets.

Pro traders know the importance of treating all trades with equal risk percentages and not getting overly attached to their positions.

The amateurs will usually make comments like this, "I took the last signal generated by my system but I lost my shirt on it, then the next signal won big but I had no money left in my account to trade it" 

In comparison the pro trader will also have taken the last signal generated by his system but will have risked only 0.5 or 2% of his capital it. He will never risk his shirt on any single trade and knows where his exit price will be before he even enters the trade.

Beginners also often neglect to use stop losses as they have no expectation of their plan failing. (Often with catastrophic results) They believe foolishly that their analysis is accurate and cannot fail, not realising that in the long run it is statistically impossible that all the trades will be winning. For sure one of the trades will move big the wrong way.

Pro traders accept losses as a normal part of everyday life, even some of the very best traders only achieve a 30%-40% winning trade strike rate, but they capitalize on these winning trades by letting them run and run until the trend changes, thus maximising their gains.

If you have read this page then you already have an edge on the amateurs.

What you need to compute optimal risk are the following statistics.

Risk / Reward ratio

This is the size of your average winning trade / the size of your average losing trade. A good trader would perhaps have a risk reward ratio of between 2 or 3 times average losing trades. If you have an average winning trade of = 2000 and an average losing trade of 800 then you can calculate 2000 / 800 = 2.5

You can use money values OR percent values just as long as you don't mix them up. Thus if your average winning trade is 2.5% of your equity and your average losing trade is 1.2% of your equity you can compute 2.5 / 1.2 = 2.08

Winning percent ratio

This is simply the percentage of trades that are winning. If you do 100 trades and 40 of them are winners you type in 0.4

What if the output number is negative?

This is the scenario when your statistics show a non profitable losing strategy. The optimal risk amount would be zero as the pay-off rate is negative. If you have achieved a zero payoff then you need to improve your system or trading style until you can get positive reading from the formula.

Consider a roulette wheel which has always got a negative payoff, which means that you would be a fool to place a bet on it. The optimal bet is zero. (Do not bet)

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Compute your optimal risk percent  here

Winning percent                               Type 35% as 0.35  

Number of open trades                     

Optimal risk percent is                        

Optimal risk per trade is                          

How to use your optimal risk percent output number

For single trades ( only one trade running at any given time )

If your optimal risk is calculated at 0.25 ( 25%)  and you do one trade at a time then you would risk 25% of your equity from entry price to stop loss.

The usual application for this formula amongst pro trader is simply to divide the optimal risk formula by the number of trade they will execute.

For a portfolio of ( 20 trades running at any given time )

If the trader runs a portfolio of 20 trades then 25% will be divided by 20 producing a risk per trade of 1.25% from entry price to stop loss.

If you are using this to calculate your optimal risk for the Trading IQ game, then you can set the intended number of trades open to 1.

How to interpret your optimal risk number

Consider this number as a measurement of success. A good trader will have a higher number than an average trader. In some cases the number could be as high as 40 or 50% or more and risking such a large amount would often make one feel that too much risk is taken on.

The formula does not have emotion or intelligence but it is always right in the sense that if you have fixed statistics of winning trade percents and risk reward ratios, then it will lead you to make more money that would be possible by risking any other amount.

As unfortunately trading is never this certain, your ratios will change all the time and therefore the optimal bet size will change with it. Computing your risk reward ratio and winning percentages over a large array of past trades will be less volatile in the output number, but if you only used the last 10 or 20 trades you did to compute it, then the results of the output number will be very different.

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All the indicators, functions, signals and formulas available from PrecisionTradingSystems have been selected for their high levels of efficiency as trading tools.

However this does not guarantee success when using them on all markets you choose to trade in.

Risk of losses are high with even the best systems, and a good understanding of risk control mechanics is required before using any products you have received from PrecisionTradingSystems.

You are responsible for ensuring all precautions have been taken in your trading decisions and PrecisionTradingSystems cannot be help responsible for any losses you may incur while using its products.

These products and formulas are designed for Traders who have several years experience of trading, if you do not consider yourself in this category then please invest some time to study your methods carefully before risking any money.