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Manage Risk with Percentage Based Trading

Whether it’s trading systems and strategies, market analysis or the holy grail of indicators, the amount of information at our fingertips surrounding futures and forex trading is insurmountable. However, one topic that is often overlooked is how to manage a futures or forex trading account.

Topics related to trade management and risk mitigation are far from attention-getters, however they are vital components to help new and experienced traders alike improve the odds of maintaining their accounts.

A conservative, thoughtful and sensible approach to reduce risk and establish a set of account management rules before entering the market was theorized by trading coach veteran, Dr. Van K. Tharp. Tharp coined the phrase “Position Sizing™”, a money management technique where only a certain percentage of the total trading account is at risk for each individual trade.

The Position Sizing™ approach focuses on account preservation and trading psychology. Employing a set of conservative rules prior to entering the market will drastically reduce the risk of a major loss should the market turn against a position. In the event the market moves in the opposite direction of a trade, traders can rest easy knowing the loss is only a fraction of the total trading account.

Position Sizing™ Example

Jane Smith is a conservative trader abiding by her own Position Sizing™ rules, and she is only going to risk 1% of her total account per trade. With a total account size of $20,000, she will risk $200 per trade.

When trading one contract of the E-mini S&P 500 (ES), which trades at $12.50 per tick, or $50 per point, she places her stop loss at 16 ticks away from the entry price (16 x $12.50 = $200). Employing a 1:1 risk to reward ratio, Jane places her profit target 16 ticks on the opposite side of her market entry. A more popular approach might be a 2:1 risk reward ratio where a stop loss and profit target is placed at 16 and 32 ticks on each side of the entry price.

Should Jane feel that 16-tick moves within the ES are not achievable, increasing the number of contracts to two would allow her still abide by her 1% risk measure and place her stop loss only 8 ticks away from her entry with a profit target of 16 ticks.

NinjaTrader’s Risk Reward Drawing Tool offers an intuitive and visual method to quickly determine stop loss and profit target placement based on user defined ratios. Once the entry and exit levels have been defined, NinjaTrader’s ATM Strategy feature helps to automate order submission & management allowing traders to stick to their predetermined Position Sizing™ rules and risk tolerance.

Risk Reward Chart

Regardless of trading strategy, indicators or approach, risk mitigation is paramount to preserve capital and the longevity of a trading account. The Position Sizing™ account management principle is just one of many methods to manage risk and while it may not fit the unique needs of all traders, the key is to have a plan and stick to it.

To give ATM Strategies and the Risk Reward Drawing tool a test drive, download NinjaTrader for FREE today!