Going “all in” with your trading account – are you a “gunslinger”??
I have a trading account with a hypothetical trading balance of $40,000 – I get a buy signal using my preferred methodology – I’m ready to execute the trade but how many contracts (shares) do I trade? Well, that all ultimately depends on your risk tolerance. Lets use the E-mini SP500 contract for this example. Lets further assume that your brokerage requires a minimum $4,000 per contract in margin. A quick calculation shows us that we can then trade 10 contracts which would max out our trading account – otherwise known as going “all in” in poker. So – my question to you is – is that OK?? Should you be doing that or is that just reckless trading – using a ”gunslinger” mentality?
The above picture (other than being REALLY cool looking!) is what most people associate traders to be. Reckless, care free gamblers hoping to hit the mother load and while admittedly there ARE traders like that either by choice or because they know no better, the vast majority of seasoned traders couldn’t be farther from the image depicted above. Most traders who trade for a living realize that managing your most valuable asset – your trading capital – is priority number one. “Live to trade another day” is a well known motto in trading circles. But does that defensive mindset of “protect protect protect” actually hamper you as a trader?? More than you know unfortunately.
As previously mentioned, going all in means to max out your entire account on a trade – however – it does NOT mean it has to be on a SINGLE trade. Lets examine margin and how it works. Its almost a given that when you open a new brokerage account they will immediately offer you the ability to trade on margin. There are interest charges should you chose to use the margin accounts but, the cost is minimal compared to what you can earn off of a trade provided of course its a winning outcome. Returning to the $40,000 hypothetical trading account, I could in theory, trade that account as if it were valued at $80,000 with margin, perhaps even more depending on your brokerage. For now though, in this example we are going to just use the $40,000 on deposit and trade the 10 E mini contracts on the SP500. My stop on the trade is the ultimate determining factor as to whether or not I should move all in on a single position or not. Personally I like to risk about -1% – perhaps -1.25% max of my trading balance on any single trade. If that’s the case, then I know my stop loss, regardless of the number of contracts that I chose to trade, should not exceed -$400 to -$500 on a $40,000 account balance. If a single point move on an E-mini contract represents $50 and I am trading 10 contracts in this “all in” example, then I am limited to less than a 1 point stop. Your timing would have to be impeccable, otherwise you will be “whip sawed” in and out of your trades all day long. Talk about death by a thousand cuts! A 1 point stop loss is just NOT practical – even for scalpers (which I dont do) its just too tight. Below is a screen shot of the risk parameters using the m3- Money Management Modeler.
ALL IN analysis using the m3 - Money Management Modeler
http://www.screencast.com/t/EOp6TxlSmd (Click to enlarge)
The percentage risk to your overall trading account is the most important metric. It is this value that clearly tells you how much damage you could do to your trading capital in the event of a losing trade. If your personal risk tolerance is no more than -1% of your trading capital then we know that you can only lose -$400 on a $40,000 account. To achieve this end AND max out your account your stop loss can be no more than .75 of a point – that’s less than a single point! This is why professional traders rarely fall into the trap of an “all in” trade. Using my methodology, which is primarily an intra day swing trader, I am looking to take between 2 and 3 trades daily. I do not scalp the market as a day trader. With that in mind, when I initiate a trade I realize the importance of stop losses but I can assure you it is a LOT larger than -.75 of a point when trading the E-mini SP500. By adjusting my stop to avoid getting “whipsawed” in and out of trades, to lets say – 3 points, I have opened up a whole new can of worms. A 3 point stop means -$150 per contract x 10 contracts traded is a -$1500 loss or a -3.75% loss to the$40,000 trading capital – that is called taking the express lanes on the road to ruin! See the 2nd screen shot below using the m3 – Money Management Modeler which shows these less than ideal settings…
ALL IN analysis 2 using the m3 - Money Management Modeler
http://www.screencast.com/t/EbWEGsIw (Click to enlarge)
REALITY CHECK …
Good money management starts with good risk management and good risk management is a function of optimal position sizing in the world of trading. Believe it or not, it applies to investors as well – not just the traders of the world. Below is the final screen shot highlighting the ideal number of contracts one should trade if you adhere to the most IMPORTANT metric of all which is again, the percentage (%) risk to your over all trading capital…
ALL IN analysis 3 using the m3 - Money Management Modeler