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

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

  1. 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":