Efficient capital management helps a trader survive in
markets with margin trading. Only with observing equivalent ratio between a
profit sum and a loss sum calculated for an average bargain, a trader obtains
an opportunity to work with funds instead of just playing. Let us consider
general principles and rules of capital management.
Total sum of funds invested should not exceed 50% of total
capital sum. This principle sets the margin calculation rule under opened
position: the sum of the necessary margin to use in non-standard situations and
to maintain normal work should not be less than a half of total capital. The value
of 50% is given by Murphy, nevertheless, many analysts believe that the
percentage of funds invested should be even less: 5% - 30%.
Total fund sum, allocated into one market cannot exceed 10%
- 15% of total capital. In this case a trader is insured against investing
excessive funds into one bargain, which may lead to ruining.
Norm of risk for each market a trader invests his funds into
should not exceed 5% of total capital sum. Thus, if a bargain turns out to be
loss-making, a trader is ready to lose maximum 5% of his total capital sum. The
figure of 5% is taken from Murphy` s work, however, for example, Elder tells
the figures of 1.5% - 2%.
Total sum of guarantee fees paid at opening positions for
one market group should consist maximum 20% - 25% of total capital. The markets
comprised by one group seem more or less similar. Opening large positions in
every market of one group violates diversification principle, therefore it is
required to be cautious with allocation of funds in similar markets. It is never
acceptable to neglect an important rule of the best allocation of funds: they
must be diversified to one or another extent. A trader` s capital must be
allocated so that losses of one big bargain could not ruin the capital and, if
possible, could be compensated with profit of other bargains. While working in
FOREX market four major markets can be distinguished, inside which behavior of
currency rates is quite similar: USD zone, GBP zone, JPY zone and EUR zone.
Definition of portfolio diversification. Diversification is
one of capital protection methods, however, diversification also should be done
in moderation. Reasonable compromise between diversification and concentration
is always needed. More or less reliable allocation of funds may be achieved by
opening positions in no more than in four-six markets of different groups. The
higher value of negative correlation between the markets, the higher
diversification of funds allocated.
Definition of Stop Loss order levels. Stop orders are
usually set for a period of a trader` s absence at his working place and their
main challenge is to save a trader against ruining (Stop Loss performance) or
ensure additional profit (Stop Profit). Stop Loss value depends firstly on the
sum that a trader is ready to lose by one bargain and, secondly, on his
calculation of the market situation. It should be noted that at definition of
Stop Order level a trader should make a decision on the basis of a reasonable
combination of technical factors, shown in a price graph, and of considerations
about his money saving. The more variable the market is, the farther should be
Stop Loss order levels from the current price level. A trader is interested in
placing Stop Loss order as close to the price level as possible in order to
minimize losses by unfortunate bargains. At the same time, too tight Stop
Orders may lead to undesired position elimination at short-term price
fluctuations (disturbances). Too remote Stop Orders are not sensitive to such
disturbances, but may cause significant losses.
Definition of possible profit/ loss ratio. A norm of profit
is defined for every potential bargain. This profit norm should then be
balanced with potential loss in case if the market moves in an undesired
direction. Usually this ratio is set as 3:1, or you should give up your
intention to enter the market. For example, if a trader sets a bargain risk of
$100, potential profit should amount to $300. As a relatively small amount of
bargains within a year can produce significant profit, it is necessary to try
to make the profit maximal with maintenance of profitable positions as long as
possible. On the other hand, losses by unfortunate bargains should be
minimized.
Trading with several positions. When entering a market with
several contracts (i.e. with concluding contracts for more than one lot), a
trader should divide them into so called trend positions and trade positions.
Trend positions are opened with quite liberal Stop Orders, which enables to
maintain these positions even in conditions of price consolidation and
correction. These are the very positions which give a trader an opportunity to
gain the highest possible profit. Trade positions serve for short-term trading
and are restricted with quite tight Stop Orders. Therefore they are closed when
certain price points are achieved, and are restored when the trend is resumed.
Conservative and aggressive trading approaches. Most
analysts prefer conservative approach. For instance, Tewels, Harlow and Stone
in their book "The Commodity Futures Game" write that long-term
success (winning in a game) is actually achieved rather by a trader with worse
opportunities to gain profit, but keeping to conservative trading style than by
a trader with vast opportunities of profit gaining but with aggressive trading style. Murphy shares this opinion and writes that
conservative players really win. A trader willing to get wealthy rapidly plays
aggressively. His profits are really essential, but only when the market moves
in a direction favourable for him. When the market state changes, aggressive
strategy usually leads to crash.
Rules of position opening:
а) open only with one main and at least one supplementary
signal;
b) at opening, please formulate and write down in advance:
a market entering price;
a profitable position closing price;
a loss-making position closing price;
rated life time of opened position.
c) open against trend cautiously and for a short time;
d) open cautiously and for a short time during flat.
Rules of position maintenance and partial closing before the
rated time:
а) maintain positions only if analysis proves the
conclusions made before;
b) close partially:
when you get loss exceeding the rated one;
if the price has reached the rated mark for profit gaining;
в) wait:
if you get losses less that the rated ones;
if the price remains at the same level;
if the price has not reached the rated mark of profit
gaining.
Rules of closing positions:
when the rated time has elapsed;
when the rated profit has been gained;
when rated loss has been borne;
when profit has reached its maximum.
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