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Money management: calculate the risk and performance

We treat now a key issue of trading: risk.

Risk is a tendency of traders, there are traders who have a high risk tolerance and, therefore, prefer to risk a higher percentage of their capital on each trade (5%), while others risk a smaller percentage (1-2% ).

However, especially if you are not an experienced trader, the risk percentage should not be greater than 2%, always remember that if today you lose 2% of your capital tomorrow you will have a better chance to recover and earn, but if you lose 10% will be much harder to recover what you’ve lost.

You decide the risk capital even before you open a position in the market, then you have to decide and invest a percentage of your capital ranging from 1% to 5%, more percentage of risk would be irrational.

FORMULA TO FOLLOW

The formula to follow, brings us back to the days of elementary school, this appears to be a simple mathematical formula that is applied every time we enter to the market and it’s used to determine the numerical value of the percentage of capital to invest or if you want to put at risk.

  • E x RP : 100 = RC

E = Equity Capital
RP = Percentage of risk
RC = Risk Capital

Imagine having a capital of $ 10,000 in your account, if you decide to risk 2% of your capital, then the formula will be:

  •  $ 10,000 x 2: 100 = $200

Each position that you open will be $ 200. If you open more positions on the same day you will multiply the result for open positions. If, however, you lose $ 200, you mustn’t calculate following the initial capital, but the residual one: 10,000 – 200 = $ 9,800. However, if at the end of the day you have a capital of $ 10,200, then the 2% should be $ 204.

HOW TO CALCULATE THE CAPITAL TO BE RECOVERED

Earn is not difficult, it is difficult to restore the lost capital, in fact, the loss of capital requires a certain percentage of performance to recover it, of course, increasing the percentage of lost capital, increases the one relative to the performance that are used to retrieve it. The formula for calculating the performance to be obtained to restore the capital is:

[100 / (100 – LP)] x LP
Where LP is the percentage of loss.
We see here below a table that shows the performance to be obtained based on the percentage of capital loss.

TIPS: As you can see, to recover large losses, we need performance that are almost impossible to be reached, for this reason, results to be essential put a risk just 2% of capital, at least until we become expert to avoid losing everything, the maximum risk to consider is of 5%.

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