This week Dominic Picarda looks at what might be considerd the most important rule of investment.
It's true what they say: size really does matter in trading.
Deciding how much of the funds in your spread-betting account to risk on each trade is an essential part of making worthwhile profits and limiting losses.
This decision is called "position sizing" and the name of the game is to ensure that your capital lasts as long as possible, even if you have a long run of losing trades.
Say a trader has £1000 in his account. He decides to do a "buy" trade on the FTSE 100, targeting a gain of 150 points and placing a stop-loss order 50 points away. He chooses to stake £10 per point on this trade.
However, instead of rising as he had hoped, the index tumbles 50 points, triggering the stop loss. He has, therefore, lost 50 points multiplied by £10, or £500.
In one trade, he has wiped out half his trading capital!
Successful Traders
The most successful traders generally follow a rule of never risking more than a certain percentage of their account on any one trade.
The most commonly mentioned percentages are between 2 and 8 per cent, depending on the experience of the trader and the asset being traded. The newer you are to trading, the lower the percentage you should commit to each position.
If your total trading capital is small, sticking to small percentage positions can be tricky. Generally speaking, spread betting firms don't offer bets for less than £1 a point.
So, if you only had £1000 in your account and applied a "2 per cent rule", you would have to place your stop-loss just 20 points away from your entry price.
Such a tight policy would probably result in your being stopped out of many perfectly good trades. In this case, you would have to opt for a higher percentage per trade.
The Maths
Example: Winning five (£500 profit) out of 17 trades (twelve losses at £40 each = £480 lost) should make a profitable trading strategy.
This is a 29% win percentage. Of course, there's always the chance you could win fewer than five out of 17 trades, in which case this strategy would fail. So, as always, you need to keep a close check on your trading record to see whether your strategy is profitable.
Should you suffer a string of losses, never be tempted to increase the Pounds per point you bet in an effort to break even. If your account shrinks, so should the money amounts you stake per trade. A percentage rule is perfect for achieving this.
Until next week, happy trading
The Tradefair Spreads Team
The above comments do not constitute investment advice and neither Tradefair Spreads nor Clean Financial accept any responsibility for any use that may be made of them.
Risk Warning:
Spread bets carry a high level of risk so you should only speculate with money you can afford to lose. You can lose more than your initial deposit and stake. Before you open an account, please ensure that spread betting matches your investment objectives, familiarise yourself with the risks involved and if necessary seek independent advice.
Article provided / approved by Tradefair Spreads which is a trading name of London Capital Group Ltd which is authorised and regulated by the Financial Services Authority (FSA), FSA Register number 182110.
Tradefair® is part of the Betfair Group.
'Trading and Stake Size' edited by DB, updated 10-Sep-09
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Risk Warning:
Please note that spread betting and CFD trading carry a high level of risk to your capital. You can lose more than your initial deposit. These products may not be suitable for all investors. Only speculate with money that you can afford to lose. Please ensure you fully understand the risks involved and seek independent financial advice where necessary.
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