protect thy wad

Protect Thy Wad

The Golden Formula

You might think that this is a very strange title for a blog post, (Protect Thy Wad) but those words have been the cornerstone of my trading for a number of years. Your list of Golden Rules should be printed out and pinned to the wall above your trading desk to keep them to the forefront of your mind.

This is not the time to discuss a list of Golden Rules but this one is so very important. Whatever your Golden Rules of trading are, they should be formulated in such a way as to keep you in the game.

 At Black Dog, our Golden Rule #1 is to PROTECT THY WAD. In other words, protect your account at all costs!

But why is this?

Hmmm, ‘Protect Thy Wad’ – three words that sound fairly innocuous if it wasn’t for the fact that your whole trading life depends on them. For, if you have no account, then you cannot trade. Simple.

Before we start to look at protecting our wad, it may help us to better understand if we could highlight a few novice mistakes which are the main reasons why trading accounts suffer. I’ll make no bones about it that I too was in

 the same novice position. If you haven’t already, please download and study the 100 Trading Do’s and Don’ts which may help highlight any problems you may have.

protect thy wad

Thankfully, the formula is nothing so complex as on the left. It is very simple.

So easy, even I understand it..!!

Trading with rigid rules like these can be costly:

  • Concentrate far too much on entries to the detriment of where you will exit
  • Trading using a fixed amount on every currency pair
  • Using the same fixed amount during periods of volatility and relative calm
  • Trading the same fixed amount even after losing half of the account
  • Using with the same fixed stop loss on all pairs, no matter the volatility

Obviously, there are many other mistakes to be made whilst trading, but if your account is suffering badly then the finger of blame will probably point to one or more of those listed above. These are BIG reasons why a trader’s account could suffer, but fortunately it is fairly easy to rectify.

But why shouldn’t we have rigid rules like this?

Have you, like me, spent days, months, even years collecting a series of trading systems in looking for that perfect means of making millions? Hoping to grow rich by following a rigid set of rules like an automaton? The fact is that trading like this doesn’t work. Which may explain why EA’s often empty accounts.

Currency pairs are not all the same, though they can be correlated. Compare, say, GBPJPY to EURGBP. The former can be very volatile at times, whereas the EURGBP often doesn’t move that very much. Having the same rigid rules for both is not very professional and will frequently get you stopped out on the Yen pairs.

Even a single pair has certain times when it flies and times when it doesn’t, it could occur during the same day. News, for example, has that effect.

On the other hand, having a fixed target price for every trade has a similar outcome. You could be losing out on many pips.

You and I, being bog-standard, lesser-spotted, every-day traders, have no means of controlling the market. It does what it does. We have absolutely no control over what it does and how it moves. BUT, what we can manage is our risk. And that is very very important. This is the one thing that we do have control overprotect thy wad

Managing Risk

Neglecting your Trade Management, or even failing to learn Trade Management skills, is a one-way ticket to Empty-accountsville. I’m not very keen on the phrase ‘Money Management’ as, during trades, this implies that your eyes are glued to the profit/loss at the bottom right-hand corner.

protect thy wad

 The term is bandied about to such a degree that it has become meaningless, hardly any impact. Your focus should be to make pips, and only pips. The money will look after itself.

Trade Management, then, is THE most important factor in your trading. Basically, managing risk. It is the ONLY thing that you can control whilst trading as the market will do what it does. We certainly have no control over that., but how to set about it?

Protect your trading account with Proper Position Sizing

This is as close to the Holy Grail as it’s possible to get. Position Sizing is undoubtedly the most important means of protecting yourself from blowing your account and thus enabling you to stay in the game. Losing a large percentage of your account in one fell swoop could feasibly take years to recoup, if at all. Not to mention the affect that it will have on you psychologically.

Risking upwards of 30 or 40% of your account on one trade is really asking for trouble and no professional trader would even consider it. The anguish caused by seeing your $100,000 capital now standing at $60,000 doesn’t bear thinking about. It’s losses like these that cause some traders to disappear altogether.

Avoiding such losses is paramount, your main defence is in your Trade Management skills – the first line of that defence is Position Sizing.

The best way is to trade with figures based on the size of your account as it stands NOW – not what it once was, or when you opened the account. Use the ATR to determine the volatility of the market. Is it becalmed or like a wild cat?

What is Position Sizing?

It is actually the glue that holds your defences together. It tells you how much to risk on any given trade, and where your stop loss should be, taking into account your personal risk.

But consider this. If you take too large a position then your capital could disappear in an instant. Alternatively, too small and your account will grow at a snail’s pace. The idea is to calibrate your trading to take into account your personal risk. Hmmm we need a happy medium, but what to do?

There are several methods of position sizing that traders use to control their risk. This post is merely dealing with the basic method that has stood the test of time. It is VERY easy to grasp so there really is no excuse for not taking the time to work out how you will go about it. By not using position sizing then it is unlikely that you will succeed at trading. How important is that?

Your Trading Plan should detail how you will set about every trade, especially position sizing, and will form an integral part of your trading strategy. How large or small the positions you take will be dictated by your position sizing plan. Plucking a figure at random is not an option.protect thy wad

A LOT of trades won’t go your way and will end up as losers so the idea is not to lose your shirt when it happens. But you need to capitalize on the winners. Your Position Size is how many lots, contracts, or shares you are going to trade, but the number is not a random figure. The beauty of Position Sizing is that it works in any market with the main objective – Protect Thy Wad.

How to protect thy wad with the Golden Formula

Fortunately, it is a simple procedure and very easy to accomplish. Remember that this is the basic Position Sizing model, there are others, but this will get you going on the right path. There are only three steps which you will soon get used to, and will be able to work it out super speedily.

STEP 1

The first thing you need to know is the size of your account! Hmm, how easy is that? That is, the size of your account BEFORE the next trade, and AFTER the last, ie, as it stands NOW.  For this example let’s use $10,000. For the sake of the formula we’ll call your account size, ‘A’.

Well, that was easy enough, and so is the next part.

STEP 2

Decisions. Decisions. You now have to decide how much you are COMFORTABLE with losing in terms of a percentage of your account should the trade go against you. There is much written about this subject but 1% seems an arbitrary amount with many traders using this figure. Some use 2%, yet others with (probably) very large accounts will use 0.5% or even less.

So, your account size of $10,000 multiplied by your risk percentage of 1% = $100. You are prepared to lose $100 before cutting the trade as a losing trade. Can you now see how your account will stay active even after a string of losses (which will happen)? Purchasing far too many lots, or contracts, than you should is not really healthy for your account. Start to trade in a constructive manner, but risking 10% a go will only result in one outcome.

Decide on your risk percentage and stay with it. This is how much you are going to risk on the next trade. For the sake of the formula we’ll call your risk, ‘R’.

The formula so far is account size (A) multiplied by your risk (R) or AR

STEP 3

This is also pretty simple. From your risk percentage you now know that you can comfortably lose $100 if the worst comes to the worst. This is the worst case scenario for this trade. This step is where you will place your stop loss.

For the sake of this formula we’ll call your stop loss, ‘S’.

Whatever figure you arrive at after Steps 1 and 2, you must divide it by your stop loss size.

(AxR) divided by S

The formula is now complete.

Using the figures from above:

$10,000 x 1% = £100

So, if I want a stop loss of 100 pips I must divide my $100 acceptable loss by the 100 pip stop loss. 100 divided by 100 = 1

I can then trade at $1 per pip as $100 is divided by 100 pip stop loss.

If I want a 50 pip stop then I can trade at $2 per pip. ($100 divided by 50 pip stop = 2).

If I want a 25 pip stop then I can trade at $4 per pip – and so on. ($100 divided by 25 pip stop = 4).

Stop placement is a whole new ball game but we won’t dwell on it here. The best place for your stop may be at a support or resistance area and could be an odd number. Some rounding up or down may be required but it’s usually better to be conservative in this approach. Err on the side of caution.

Can you see how position sizing has a huge impact on your risk and your overall profit? You are now calculating your risk using whatever stop loss you deem fit. You are now in a very strong position to Protect Thy Wad..!!

If you lose 1% you still have 99% left! A string of losses will not place your account on the terminal list.

Who can use this formula?

Well, this 3-step method gives the ideal position size for any, and all, trades in any market. It does not matter what type of trader you are; swing, day trader, position trader, it works for all types.

I trade at a dollar amount per pip but you may trade in lots or contracts. You will need to get to know the pip values of what you trade in this case. You’ll soon be able to work out what position size you need, fairly quickly at that.

Define your risk (what you are willing and comfortable in losing), and don’t change it. Next, where should your stop loss be? Then calculate your position size – it is a very simple calculation.

For EVERY trade you can risk the same dollar amount. 

You will NOT be risking more with a larger stop loss size. If you need a larger stop loss then reduce the position size. Very simple. The opposite is also true, a smaller stop loss size allows for a larger position size. But not too tight!

If you want to risk that same $100 as above on the next trade but need a 50 pip stop loss as opposed to the last trade where you needed only a 25 stop loss, and 50 pips is the best place for that stop loss. Then simply divide your acceptable loss of $100 by the new stop loss size, so; with the larger stop loss you can trade at $2 per pip as opposed to $4 per pip on the last trade.

You are now controlling your risk admirably.

NEVER move your stop loss to accommodate your position size

ALWAYS calculate your position size from the required stop distance.

Conclusion

Points to remember:

a – Golden Rule #1 Protect Thy Wad.

b – EVERY trader has a string of losers.

c – Overnight gaps could blast through your stop loss.

d – You must be happy with what you set as an acceptable loss (percentage of your account).

e – Forget those rigid rules of trading.

You are now starting to trade like the professionals, in any market situation, volatile or not, by risking the same amount on every trade. By trading a lower $ amount per pip when the market is volatile and requires a larger stop loss, or increasing your $ amount per pip when the market is not so volatile and requires a smaller stop loss.

Now, no currency, future, stock, or commodity is riskier than the other. Risk is in a state of equilibrium. You have balanced it out. You are in sync with your trading, the market, and yourself.

A problem that most of us suffer from is Greed. Having unduly large stops to enable larger position sizes. Over time the account will only head south. Use position sizing and you will start to feel more ‘at ease’ with your trading, more confident, and ultimately protecting thy wad. You will start to feel good about your trading because you now know what you are doing.

Remember’ Position Sizing is your first line of defence.

Please let me know what you think.

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