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# Whats a good solid fundamental risk management plan - something to start with

Discussion in 'Risk Management' started by Kastro_316, Nov 13, 2007.

1. ### Kastro_316

Hi there,

I am chaning up my risk management.

What do you all think is a good starting point/benchmark for a solid risk management plan for FX.

Something that will yield me in the positive if I have 1/3 winners.

2. ### ronblack

Hmmm... 1/3 winners? Do you mean a success rate of 33.33%?

That really says nothing. You need to specify the profit factor of your trading method and also the ratio of average win to average loss.

P = success rate:
PF = profit factor
R = average win to average loss

The above parameters are related by the following formula:

P = PF/(PF+R)

If P is 0.3333 and R = 2 then if you solve for PF you get:

PF = PxR/(1-P) = 0.3333 x 2/(1-0.3333) = 0.9999

Ah... you are not making any money

Conclusion, given a fixed success rate, in your case 1/3, your only chance before you even start thinking about money management is to make sure your R is high enough. In your case then, you are probably talking something like trend following. Solving for R we have:

R = PF x (1-P)/P

For P = 1/3 and PF = 2, then R = 4 based on the formula above and this means to get a reasonable profit factor you need average winners 4 times as large as average losers.

Then, money management is easy. Just risk no more than 2% on each trade and after some time you will be rich.

A derivation of the formula I used can be found in the excellent paper by Michael Harris "Derivation of the Profitability Rule and its Application in the Discovery of Trading Systems Based on Price Patterns":