I love to trade. I can do it where i want (given internet availability). So i want to write a series on that.
The first impulse of any reader would be – you need a lot of money? I would answer – No. the next reaction would be – It’s too risky. I would answer – First define your risk (that is – can you limit your risk so that you are 100% certain that if anything goes wrong, you can only lose X amount of dollars). People say – that is impossible. No, i have done it, i will show it to you.
Any trade that you place must satisfy the basic conditions of trading. Why? Because they would help you set up a trade for maximum profit potential. Any random trade can be placed with a 50% chance that it would go up or a 50% chance that it could go down. It is like betting on coin flips – there is a 50% chance of either heads or tails. You want a chance of 51% to start making a profit. Think about that – just 1% increase in chance of profit would give you a profit. This is fundamental to trading, or for that matter life. Isn’t it? Consider the Pareto principle – 80% of any profit comes from the vital 20%. That is, if you keep yourself from losing just small amounts and setting your trade for maximum profit potential, you just need to be right 20% of time to make good money.
Consider the following chart
Now let’s do an experiment – You start with 4 dollars, and you take 10% out of it and make a trade. If you get heads on a coin flip you get 2 dollars and you lose 1 dollar if you get a tail (2:1 risk management). Please keep in mind that there is just 50% chance that the market goes up and down, and exactly analogous to that there is a 50% chance that market would go up or down. Even after that you made a profit of 26%!! That is $5.04 is your final ending equity and you started out with $4.00, so the profit percentage is (5.04-4.00)/4.00 = 26%.
Now just by increasing your chance by proper trade setting can help you enormously.
But how much do you place in a trade? Consider the above coin toss.
I personally think risking 25% is too much. I like risk just 1% initially. That is if you $ 5000.00, just put $50.00 into one trade. But you also want to cut that risk by 90%. That is, you are only willing to lose 10% of the 50 dollars that is just $5.00 in any trade. You are being most conservative, extremely conservative. That is preserving your life saving really means preserving your capital for life. This is where a proper trade set up will help you be in the market for as long as it takes.
Cut your losses ruthlessly. If you find, after all the precautions, that the market goes against you, just cut losses and run. There are thousands of opportunities – it is like trains coming into a Tokyo metro station. One comes and other goes. But preserving your capital is paramount. It is easier to make up for 8 – 10% loss than making up for 25% loss.