This week’s question comes from Maanda, who asks:
I would like to know the percentage of your open trades compared to account value? In other words I want to know how much you would normally trade if you had a $1000 account? Do you have a limit or you open trades as opportunities happens?
There are a few ways I’d like to address this question because it raises some interesting observations.
Also, what we often read in the books or elsewhere online doesn’t always hold true. It always sounds good until you try to implement it into your trading.
I’m mostly referring to rules like risk 2% of your account balance. Or, only open a maximum of three positions at one time.
Those are incomplete statements and to be honest, they can get you in a heap of trouble if you aren’t careful.
Don't Focus on Making Money
Before we dive into the nitty-gritty, I want to cover an important concept.
Usually when I say “don’t focus on making money,” the response I get goes something like this…
But Justin, how can I expect to become a profitable trader if I’m not focused on the money?
There’s your challenge. If you can learn to separate the money from trading, you stand a MUCH greater chance of succeeding.
Of course, you need rules like how much you should risk at one time, but focusing on this too much can be problematic.
Today’s question is about how much capital I’m willing to risk at any given time. In essence, this trader wants to know my risk tolerance.
What if I said my rule is to have no more than 6% of my account balance at risk at any one time? (this is not my rule, by the way).
Now let’s assume I risk 2% of my balance per trade. This means I can open a maximum of three trades at one time without overstepping my boundaries.
This is a terribly flawed approach.
Because traders who think this way are focusing on the wrong thing. They’re focused on the quantity of trades taken rather than the quality.
And contrary to popular belief, more trades does not necessarily equal more profits. In fact, I’ve found the opposite to be true.
When you set a rule like this, what you’re really telling yourself is – let me go look for three trades right now.
At least that’s what most traders do. I know because I was once in those shoes.
If you give yourself this kind of freedom to open trades, chances are you’ll take full advantage of it. And that may not be such a good thing.
You have to let the market come to you. Only it can dictate how many favorable setups are offered each week, month and year.
And if you try to force its hand, it will bite you.
Okay, So How Much Should You Risk?
Now that we’ve covered the idealistic side of things, you’re probably wondering how much simultaneous risk I take on at any one time.
The truth is I never have this issue. This is because I’m extremely selective about the setups I take.
Sure, I have a rule, but it probably isn’t what you’re thinking. You’ll see what I mean shortly.
If you’ve followed me for a while now, you know that I typically only trade four to maybe ten times each month. So the odds of having exposure on more than one or two setups at a time is pretty slim.
But if I do run into this dilemma, I always keep my risk within acceptable limits.
That may sound a bit obvious, and it is, but here’s a question where a lot of traders get tripped up.
How much risk can you tolerate?
Most traders I speak with don’t have an answer, at least not right away.
The rest of the conversation usually goes something like this…
Trader: I risk 2% of my account balance on each trade
Me: And how much is that?
Trader: Well, it’s 2%
Me: Right, but how much money would you lose in the event of a total loss?
Trader: …I’m not quite sure
Usually, after a moment of silence, they come up with the answer. But not knowing right off the top of their head is an issue.
Having a rule defined as a percentage is important, but it’s just as important to know how much money is at stake.
After all, it’s the loss of money that triggers the emotional response. The percentage alone is meaningless.
Once you’ve figured this out, determining your simultaneous risk across all open positions is easy.
Keep it simple and be sure to choose numbers you’re comfortable with. If a percentage or dollar amount gives you the slightest bit of anxiety, lower it and keep lowering it until the anxiety disappears.
Emotions are the number one killer of trading accounts, and they always come into play after a losing trade.
Reduce your risk, reduce unwanted emotions.
A Two-Part Solution
Open exposure is never static. It’s always changing as the market ebbs and flows.
For instance, let’s say you have three open positions. Only one is in profit, and you’ve covered your risk entirely by trailing your stop loss.
The other two positions are relatively new. Each one carries a 2% risk (of your account balance) for a total risk of 4%.
Just two days later, one of those two trades is in profit by a considerable margin. You’ve trailed your stop loss, so you’re now left with exposure from just one position.
As the market ebbs and flows, so too will your exposure.
Now, the key here is to define a single maximum amount you feel comfortable risking. But just like I mentioned above, that figure should be represented as both a percentage and dollar amount.
Let’s assume for a moment you’re trading with $10,000. You’ve decided that your maximum simultaneous risk is 5% of that amount.
However, after thinking about it, you aren’t so sure you’re comfortable risking $500 at one time.
All of a sudden that seems like too much money.
See how a measly figure like 5% can take on a whole new meaning with a dollar amount next to it?
With this new information, you decide to drop it from 5% to 4%. Not a huge percentage change, but that 1% reduction just shaved $100 off your maximum exposure.
So there you have it. The most exposure you’re willing to take on at one time is 4% of your account balance or $400 if using a $10,000 account.
Remember to write it down this way too. Having the dollar amount next to your percentages is essential to accept the risk fully.
At the end of the day, it’s about finding what works for you. The numbers in this post are just examples so be sure to test various approaches as you progress.
What's My Rule?
My rule for taking on simultaneous trades is simple. That’s because it’s the same as my risk per trade.
You see, I don’t have a separate rule for exposure from multiple positions. The rule I use on a per trade basis is the only one that matters to me.
If I’ve set my per trade rule in a way that prevents unwanted emotions from cropping up, why would I want to take on more risk at one time?
It just doesn’t make sense to me.
Does that mean I’m limited to one position at a time?
Not necessarily. As we just discussed, exposure is dynamic, never static. So if I want to take on additional exposure, I need to cover some risk first.
If I’m unable to do that, then I’m forced to sit on my hands, and I’m fine with that. It’s better to have one well-managed position than three mismanaged ones.
This approach won’t work for everyone. And that’s okay. It just happens to fit my views and style of trading.
Start letting the Forex market come to you and try to avoid setting a rule for the maximum number of simultaneous trades. It will be too tempting to max out that number, which means you’ll be focusing on quantity rather than quality.
What matters is the process. Identifying key support and resistance, trend analysis, favorable risk to reward ratios, confluence, etc. These are the things that matter.
If you’re trading from the higher time frames (4-hour and daily charts) and being selective, the number of trades you take at one time shouldn’t be an issue.
If it becomes a problem, you’re likely overtrading.
Your Turn: Ask Justin Anything
I’d love for this new weekly Q&A to be successful and provide an invaluable repository of answers to common Forex questions.
To do that, I need your help.
Here’s what you can do to get involved and have your question answered in next week’s post:
- Ask questions. Post them in the comments below or Tweet them to me @JustinBennettFX
- Help me answer questions. If I missed something or if you have something to add, don’t hesitate to leave a comment below.