Part 1: Percentage vs. Fixed Amount
I recently read an article by Nial Fuller that really surprised me. (Note: I strongly AGREE with Nial on SOME of his points).
Nial talked about why you shouldn’t use a Risk Percentage, but rather a “fixed risk amount.”
His point was that a fixed amount could help you get out of a drawdown faster when you winn a trade, whereas it would take a long period to get out of the drawdown if you continued to use the same Risk Percentage.
This makes sense in a very specific circumstance, but I have to say that I think it’s a very narrow view of Risk/Money Management.
Now, please understand: We, at Winner’s Edge, do NOT suggest the idea of always risking 2%. There is more to the story than that, and I will get into that in the next article, but for example sake I will use the 2% rule in this article as it is a very common percentage used.
Below, you’ll see an illustration of how a “fixed amount” hurts you on BOTH drawdowns and winning streaks; and if you’re a trader, you know that traders definitely go on streaks.
The green represents using a fixed risk percentage. This is what we always teach at Winner’s Edge in our free content and in our trading room.
The Red represents using a Fixed Dollar Amount.
Let’s break this down quickly in case the Info-graphic above didn’t clarify it for you.
A trader with a 10,000 account may use 2% risk ($200 of risk) OR use a standard dollar amount (like Nial suggests) of $200.
Now, let’s assume that trader goes on a 10 trade losing streak (very likely to happen over the course of a few months of trading assuming this is an intra-day trader).
The account size will lessen each time the trader takes a loss SO the percent risk will also lessen the dollars that are lost each trade. If the account get’s down to 9,000, the risk will be 180 dollars compared to the trader using the fixed amount who is still risking a full $200.
When the 10 trade losing streak is over, the percentage has helped eliminate SOME of the pain, where the fixed amount has not. A full $2,000 would be lost (or 20% of the account) using the fixed amount; while the risk percentage still got hit with an ugly loss of $1,829.00 (about 18%).
Both drawdowns are certainly bad, but when capital preservation is the number one rule, I think it’s safe to say that a full 2% LESS drawdown is a big deal.
And the same principle applies when that trader goes on a winning streak:
A fixed amount doesn’t take into account the growing balance and therefore limits your leverage and your gains when the tide is turned.
For me, as a trader who goes on streaks, the evidence is clear. Trading with a percentage simply makes sense.
Before I pass along the next article concerning Risk which is going to dive into What Percentage You SHOULD Risk, I want to get your feedback on part 1.
Share it if you don’t mind, but more importantly, leave a comment with your thoughts. Feel free to disagree with my analysis, but be sure to tell me WHY if you do disagree.
Thanks so much for taking the time to read, I’ll be sending part 2 out very shortly!
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