The account risk of each position is best handled when each position risk is managed to limit the total risk a position can assume.
It is also important to allow enough risk to enable a reasonable order quantity be allowed to help grow the account's balance at a safe rate that doesn't cause draw down periods that enable a trading account to lose all or most of its money, or cause the trader to lose confidence in a system.
Risk rate boundaries are different for each of us because our beliefs and expectations are all different. However, each of us can discover our thresholds with system historical testing and personal reflection. Ideally, the amount of risk each of us allows isn't so large that a position's failure becomes a significant event during a prolonged draw down cycle. Large losses during difficult trading periods will quickly consume an account to the point where there is too little money, or too little courage to keep trading.
Finding this balancing point for each of us is the critical goal for all traders. It is important because draw-down periods are going to appear at some point, and long draw-down periods are hard on the account and the trader's confidence in the systems. This means the total risk level a trader exposes to their account must be kept low enough that hard times don't don't drain the account, or destroy their belief in the system. Instead, it provides a practical level of controlled risk during up and down market cycle period that enhance the trading account's value.
Total Account Risk:
Total account risk is the sum total of each active position's risk. How many active positions to allow at the same time determines the percentage of account risk. A major portion of how much risk a position contributes to the total risk exposure is influenced by how far prices can be allowed to move against a trade before that trade is terminated. Order risk is determined by measuring the current close price to the On-Stop Exit price to determine the amount of risk points. A single contract, or share risk points converted to a currency value is the basis for determining how much risk a position will be allowed to assume when the order is given a quantity size. In simple terms risk is based upon the cost applied to a single contract or share when prices move against a trade's position. This adverse point difference is converted to a monetary value so that risk, as amount of loss, for a single contract can be used to estimate how many contracts or shares can be assigned as a quantity for a new order. Determining how much money to allow a position is determined by the system's allowed risk rate for sizing orders.
When an order is created and sized to have only 1-contract, the risk of the position is the risk of that single contract. When an order is sized with more contracts the number of contracts times the risk amount of a single contract determines the position risk. Contracts that use risk based sizing are designed to limit total entry position risk to the system's position allowed risk sizing rate. Multiple positions sized and constrained to the system's risk rate can be summed to determine the account's total risk rate.
When an order is generated with a risk amount for a single contract that is larger than allowed, the fixed quantity method of sizing will allow the order to reach the brokerage because there is no risk filtering logic in that order sizing module. While this might sound risky, fixed quantity sizing is the best way to check on how the software handled the transactions. By understanding the transactions the cost of slippage, and commissions, when allowed during a test, can be seen in how the position is settled at position termination.
When a system wants to have better risk control, the process of sizing should use logic that will limit the position allocation amount to the trader's risk rate so an order with excessive single share or contract risk levels are rejected, and those with small levels of risk will be allowed to have more than a single contract or share. In Trading Blox the "Fixed Fractional Money Manager" and "Multi-Money Manager" blox modules have risk filtering logic and allow the user to establish the risk rate for each new order.
This completes this topic.
Edit Time: 10/6/2017 2:03:04 PM
Topic ID#: 425