Why do most traders fail?
There are several reasons why most traders fail. A few are:
- They don’t know the trend
- They don’t know the targets
- They don’t have a system
- They don’t have a trading plan
- They don’t follow their rules
- They don’t protect their margin account
Most of these items are a discussion for another day. Today we’ll discuss protecting your margin account using Margin Management.
What does it mean to protect your margin account?
Your margin account is the money you use to take trades. You pay the required “margin” on the trading instruments upon which you will enter positions. The margin is the amount of money “down” that the broker requires for you to handle a trading position. Typically it is anywhere from 50% of the value of the instrument up to 0.1% of the value of the instrument. It is extremely important that you protect your margin account. Obviously, if you have no margin account, you can’t trade. So you have to limit your trades so as not to lose your margin account.
How do I limit my trades?
Typically you will use a Stop Loss to limit your trades. The purpose of your Stop Loss is to protect your margin account – not your trade. If you start with a trade that’s too large and allow it to swing too far against you, eventually you will run out of money to maintain the loss. Then your broker will execute a “margin call” on your account – closing all your open positions at the worst possible time. Sometimes when you get a margin call, depending on market conditions, you may end up owing your broker more money than you had in your account. You definitely don’t want to be in that position. So you must limit your trades by ensuring the trade is not too large and won’t swing too far against you. For that you will most often use a stop loss order that will close your trade when it reaches a certain level.
So, how do I use a stop loss to limit my trades?
Your job as a trader is to risk. Think about your local grocery store guy. He’s going to buy a container full of bananas. First of all, he knows that, perhaps 10% of the bananas are already rotten. But he’s going to risk his money to bring in a bunch of bananas that only have a shelf life of about five days.If he doesn’t sell them in five days, he’s going to have a loss. But he believes he can sell them in five days, so he risks his money buying the bananas. He accepts that risk when he decides to make his purchase.
That’s exactly what a trader must do. Most traders will accept the reward of a trade, but few accept the risk. The difference between Professional traders and Retail traders is that Professionals spend all their time in the risk calculations and Retail traders spend all their time in the Reward calculations. They are trying to find what they perceive to be a great trade instead of letting their margin management dictate a great trade and when to take it.
For example, if you have a $5000 account and choose to risk 5%, you will have to accept a risk of $250 because no one can trade with 100% accuracy. If you cannot accept a risk of $250, then you can’t trade at 5% risk. 2% risk means you have to accept a risk of $100. If you have trouble with this, break it down into smaller pieces – trade a mini instead of a standard, trade a micro instead of a mini. That will allow you to manage your account more easily.
The Next Puzzle Piece: Trade Size
Once you know how much you are willing to risk, you can find the other two pieces of the puzzle. The next is to define whether the chart will uphold the risk – this part will tell you how many lots you can trade.
For example, if you are risk 2% or $100 of your account, then your trade size can be:
- 1 mini at 100 pips risk (stop)
- 10 micros at a 100 pips risk (stop)
- 2 minis at 50 pips risk (stop)
- 20 micros at 50 pips risk (stop)
- 3 minis at 30 pips risk (stop)
- 30 micros at 30 pips risk (stop)
The question is, what level does the chart tell you it will uphold for your stop?
If the chart tells you that a 30 pip stop is all it technically will hold, you cannot wisely use a 50 pip stop since the probability is high that you will lose an extra 20 pips. So you must adjust your trade size strategy to compensate – always lowering your risk, not increasing it! If you decide to use a 50 pip stop, then divide your trade size in half because you have almost doubled the stop loss.
You’ve GOT to know where your target is and hold for it!
Once you’ve defined your risk, you must ask: what target does the chart tell you it will potentially do? If you don’t know where the target is, you will lose because the name of the game is staying in until the target is hit.
The minimal acceptable trade is a 1 for 1 reward for risk ratio (1:2, 1:3 is better)
That is the minimum.
If you have a 50 pip stop on this trade, your target must be at least 50 pips away or you pass on the trade.
You must be committed to staying in that trade for the 50 pips – no clicking out for 5 because then your risk would be 50 pips for 5.
Handling Margin Management in a choppy market: Use three positions with the same stop loss, closing the first position at the first target, move stop to break-even on the other 2 positions. Close second at the second target and follow stops on the third. Again, you must be committed to staying in the trade until you hit the target or stop loss.
Lastly and most importantly, you have to ask if you can live with these rules? If not, you must adjust them so you CAN live with them. Remember, the professionals NEVER violate the rules. If you want to be profitable, then you must follow your rules to the letter.
**This Stuff Matters:
These lessons came from education from Scott Barkley–the best trader I know.
And it’s the simple concepts, discipline and intelligent rules that we discussed today that will help you become successful.
That is why we support Scott so strongly.