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Saturday, April 18, 2009

Forexct- Trade Size Importance

By Forextraderreport

One of the major mistakes that most traders will make will be the amount of capital that they place per trade. So how trade to ensure you become successful? Size is the Key The well-known goods trader Ed Seykota, who turned $5,000 into $15 million over a period of 12 years, was teaching a form in technical trading to a college class some years ago when he decided to conduct an experiment to illustrate to his students the value of money management, or position-sizing - that is, learning how much money you will risk on any individual given trade - to the universal success of any trader's trading plan.

He told his class they were going to compete in a trading contest with each other. Each student would start with a theoretical equity stake of $100,000. The winner, of course, would be the pupil with the most money at the end of the competition. However, there was a catch: Each pupil would buy and sell the same stocks at the same right time, significant those stocks would rise or fall exactly the same amount. In fact, Seykota pulled each "stock" out of a hat at the front of the room, and simply said the students whether it had gone up or down and by how often.

How do you conduct a trading contest when everyone buys and sells the right same stocks at the right same time? It is all about position-sizing - how often money you are willing to bet on each trade. After Seykota chose each stock, but before he alleged whether it had gone up or down, each student was required to write down the amount of money he or she was willing to risk on that trade. They could risk as little or as often as they wanted.

The results of the competition provided quite an education for Seykota's students - and should be remembered by anyone who puts their hard-earned money at risk in the market. By the end of the competition some of the students had lost their entire supposed stake and were entirely "broke". Others had come out about even, making a little money or losing a little money. But a few of the best students - the best traders - had turned that supposed $100,000 into over $1 million!

Think about it: Two traders start with the same amount of money and buy and sell the exact same stocks at the right same time. One goes broke. The other makes 1,000%! Therein lies the secret to survival, and ultimately success, as a trader. All the great traders will tell you that position-sizing is the individual most important factor in their success.

So how often should you risk on any single trade - in other words, how much should you be willing to lose? It is best to risk a fixed percent of your account value on every trade, and not vary that percentage from trade to trade. What that percent should be depends on several critical factors. The most critical are your win-loss ratio, the size of your average win and the size of your average loss. Given these three numbers, your position sizing will determine whether you live or die as a dealer.

The point of position-sizing is to be sure that you don't break the bank during a losing streak. Even a random coin toss can produce 10 tails consecutively, so make no mistake that even the best traders suffer through losing streaks of equal length. If you risk, say 10% of your account on every trade, and your average loss is 7%, a losing streak of 10 in a row could be destructive. On the other hand, if you are a day trader and your average loss is .5%, you can risk more money on each trade without worrying about a losing streak taking you out of the game.

Seykota says he never risks more than 5% of his account on any single trade. some other highly successful traders think risking anything more than 3% of your account on a single trade makes you a "cowboy". A good beginning point for beginning traders is probably 1% of your account. The added advantage of lower risk for beginners is that it helps minimize the emotions that often interfere with good trading.

For a detailed discussion of position-sizing, we highly recommend Van Tharp's book "Trade Your Way to Financial Freedom". An internationally renowned trading coach, Tharp was profiled along with Seykota in "Market Wizards", Jack Schwager's classic collection of profiles of some of the most brilliant traders and trading minds of all time.

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