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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, 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% win 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 the paragraph above you already have an edge over the amateur traders

What you need to compute optimal risk is 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 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 can type 0.4 which expresses 40% as a mathematical number.