Today’s article is about a seemingly obvious concept. How to measure trading profits. However, most traders start measuring their profits (and losses) completely wrong and it’s not really their fault. Conventional thinking, and what is commonly circulated on the internet and even recommended by brokers and many books, is how a real professional trader thinks about measuring his performance and managing risk in trading. not (they are closely related).
So today I want to give you a real-life lesson that you probably haven’t read or heard anywhere else on how to properly measure trading performance and risk in the markets. It is a very important factor for your trading career and if you don’t understand this part you can’t really expect to make money in the market. i think you agree.
As you know if you follow my blog even a little, I’m primarily a swing trader and that’s the trading style we focus on here and teach our students. Why is it important? Different trading methods measure profit differently, so for swing traders like you and me, there is one way to measure profit that is clearly more logical and simply “better” than the others.
However, before I discuss how I measure risk and reward when trading the markets, let me be fair and transparent and discuss the three main ways traders measure this. We will discuss each of them and then explain what most professional traders focus on and why.
Three main means of measuring profit:
- “2%” method – Traders choose to risk a percentage of their account (usually 2 or 3%) for each trade and maintain that risk percentage no matter what. The basic idea here is that as traders win, they gradually increase their position size in a natural way relative to their account size. But what usually happens is that the trader loses (check out this lesson on why traders fail, for many reasons explained in my other articles). Then the 2% rule (2% means less risk if you lose) makes it harder to get your money back, let alone actually make money!
- Measure pips or points – Traders focus on pips or points earned or lost per trade. This method is so silly that I won’t cover it much. Trading is a game of winning and losing money, not points or pips. So the idea that focusing on pips will improve performance without being so money conscious is just plain absurd. No matter what, you will always be money conscious. Emotions can only be controlled by properly controlling the risk of each trade. This means you need to know what you are risking for each trade, in currency format (dollar, pound, yen, etc.).
- “R” or fixed $ risk-based measure – Traders pre-determine how much they can lose on a single trade and risk the same amount on every trade until they decide to change that amount. The amount you risk per trade is known as ‘R’. where R = risk. Rewards are measured in multiples of risk, so 2R reward is twice his R, and so on. Yes, this method involves some discretion, but let’s be honest, discretion and intuition in trading is a big part of what separates winners from winners. loser. I’ll explain more as you read on…
Fact: Size doesn’t matter.
A recent study I read about what women considered to be the most important trait in men…just kidding! smile. I’m serious, but…
Risk per trade should be a deeper thought process. It should be personal, based on the circumstances and the trader’s overall risk profile and financial situation. for example:
As implied by the 2% rule, Trader A, who risks 2% of his $5,000 account, has a very different living environment (financials, etc.) than Trader B, who risks 2% of his $5,000 account. I have.
Now answer this: The actual amount that two very different individuals would risk from that 2% may or may not make sense given their particular circumstances. So why on earth would two completely different individuals risk the same percentage of trading accounts? The 2% rule is designed to be ‘easy’ and ‘makes sense’ for the average beginner trader, but as I said before, it actually causes traders to lose slowly. For the seasoned trader, the 2% rule is like a death sentence by “shredding”.
This makes a lot more sense with the $ risk model. This is because each trader has a different risk profile and personal situation, and you should (or should) consider how much you are comfortable risking on each trade. The 2% rule of risk is simply an arbitrary dollar number that may or may not make sense for a particular trader with a particular situation and financial situation.
Also, in Forex, the size of the account is really arbitrary as the Forex account is just a margin account. A trader who understands these facts would never put all their trading funds into their trading account. Because it simply isn’t necessary, and it’s not as safe or profitable as keeping that funds elsewhere.
The amount you deposit into your trading account does not necessarily reflect all the income you need to trade, nor does it reflect your overall net worthHowever, stock trading requires more funds in deposits due to the less leverage available. Normally, if he wants to manage 100,000 worth of shares, he needs 100,000 in his account. As already mentioned, forex is much more leveraged. This means that you only need about $5,000 in your trading account to manage 1 standard lot of 100,000 currencies.
The Myth of Compound Interest and the 2% Rule
One of the big, if not the biggest, reasons why so many people push the “2% money management rule” is the ability to exponentially increase your position size as your account grows. because it seems to show In theory this is correct, but in the real world it’s garbage. Please let me explain…
Professional traders withdraw money (profit) from their trading account frequently (usually once a month or once every three times), after which the account returns to the “baseline level”. Therefore, the 2% model never increases the position size forever. Because it doesn’t make sense not to withdraw any profits you make from trading. After all, the whole point of trying to make money in trading is to spend real money, right? The fixed $ risk model makes sense for professional traders who want real income from their trades. That’s how I trade, and how many others I know trade.
So if trading is a profitable business and you derive profits for living/spending compound interest will be affected dramatically and not at all what it seems. Do not believe everything you read or hear on the internet. not. There is no risk/money management method that will magically compound interest forever. that’s not realistic.
With the 2% or %R rule, your position size will grow as your account grows, but when you withdraw money from your account, your position size will decrease significantly and suddenly you will be trading a much smaller amount than you actually are. will be done. It was just The fixed $ risk model avoids this and keeps everything just right, even and consistent.
How much should you really risk per trade?
Now, you might be thinking, “Nyall, how do you know how much you need to risk per trade?”
The answer is not as complicated as you might think. Decide how much you can afford to lose on a single trade, and keep that amount at least until your account doubles or triples, at which point you should consider increasing it.
This amount must meet the following requirements:
- Risking this amount allows you to sleep soundly at night without having to worry about your transactions or confirming them from your phone or other device.
- When you risk this amount of money, you don’t get hung up on your computer screen getting emotional every time you agree or disagree with your position.
- If you risk this amount of money, you should be able to pretty much “forget” the trade for a day or two at a time if you want. And you won’t be surprised by the results when you check the deal again. Think of it as “set it and forget it”.
- If you risk this amount of money, you should be able to comfortably take 10 consecutive losses as a buffer without experiencing significant emotional or financial distress. Not if you’ve mastered an effective trading strategy like my three core price action patterns, but for psychological reasons it’s important to allow yourself that much slack.
Fixed $ Risk vs. % Risk
“It has to be logical. What is the true measure of a trader’s performance?”
If you’ve read my other articles on this topic, I argued in favor of the fixed dollar risk model and against the 2% rule, but in case you missed the lesson, the fixed I would like to explain again why we prefer the dollar risk model over the latter…
My main argument on this topic is that if the trader hits a string of winners, the 2% rule will cause the account to grow relatively quickly, but after the trader hits a string of losers the account will actually grow. slows down and makes it very difficult. Restore your account to its previous state.
This is because with the % R risk model, fewer lots are traded as the value of the account decreases. This can be good for limiting losses, but it’s also inherently a very difficult rut to get out of. For example, if you withdraw 50% of $10,000, you are at $5,000 and need a 100% return to get back to $10,000. Using the 2% rule goes a long way to breakeven and profitability. When you draw down, you are effectively trading with a much smaller position size.
This is why I say that the 2% model basically leads the trader to “1,000 cuts to death”. This is because traders tend to lose slowly as their position size shrinks with each loss. Traders lose their confidence and end up overtrading because they start thinking “my position size is decreasing on every trade so it’s okay to trade more often”… they You might not think so exactly… but it happens often.
I personally believe that the %R model makes traders lazy…it makes them take setups they wouldn’t otherwise…because they now risk less per trade , they don’t value that money that much…it’s human nature.
Conclusion…
If you only remember one thing from this lesson, remember that the most logical way for traders with an effective trading edge to measure their trading performance or (profit) is the fixed risk or R model. please give me.
We do not recommend that traders use the “2% rule” or fixed % model, but rather risk an amount of money that they are perfectly happy to lose on any given trade. Remember, in a series of trades, you never know which trades will lose and which will win. So it’s silly to take more risk just because you “feel” confident about a particular trade. If the amount of money you are risking per trade is enough to keep you awake at night, it’s too much risk and you should dial it down.
Remember, professional traders learn to use their discretion or “gut feeling” to decide whether or not to take a particular trade, and are very picky about which trades to take. This is gained through screen time and practice, so you should spend time honing your skills on the demo trading platform before going live. Today’s topic was money management, how to become a successful trader Remember that you also need sound trading psychology and good trading methods. If you want to learn more about my fixed risk money management method and how to trade charts based on price action analysis, check out my Advanced Price Action Trading course.
Leave a comment below with your thoughts on this lesson…
If you have any questions, please contact us here.
