It’s an uncomfortable feeling to have someone come along and tell you you’ve been doing it wrong for years.
My kids like to tell me that I’ve been eating bananas wrong (apparently, you’re meant to open them at the other end).
But this is about managing trades.
It’s not a bad thing to be forced to question the way you do stuff from time to time, but it takes a bit of effort to adapt.
For years, I’ve berated traders who blindly stick the same stake into trades, whatever the risk of that position.
Instead, I’ve meticulously calculated a stake for each and every trade, based on the percentage risk I’m taking, and the distance to my stop level.
For example, if I’m risking 2% of a nominal £10,000 fund, that’s £200 risk per trade. If my stop distance is 100 points, then my stake on that trade would be £2.
But that style of trading is becoming tricky to manage. Especially if you’re opening multiple trades at a time and don’t want to give your broker your life’s savings to “look after”.
It’s that now-familiar villain on the horizon … the new leverage regulations, coming in less than 2 weeks’ time.
The problem with changing our stakes all the time is that it gives us wildly differing margin requirements.
A £1 stake might have a requirement of £350 … and a £2 stake will have a requirement of £700 (even if the stop-based risk on those trades is identical).
A simple way to smooth out these issues is to base your stake on the margin requirement rather than the stop distance.
Many traders do this already. Val Harrison set up the HAV Trading method this way (although I can remember grumbling to him about it at the time!)
As a dyed-in-the-wool spread-better, it doesn’t come naturally to me. I like to focus on my trade parameters, rather than the scale of the underlying market. But it does remind us of what we’re actually doing – trading large (and sometimes volatile) instruments.
But don’t forget your risk
A few weeks back, I wrote to you about close-out margin – this is the drawdown that your broker will allow on your open trades.
Let’s look at another example. This time I’m placing a trade with a stake of £1, with a margin requirement of £350 and stop distance of 200 points.
If I put exactly £350 into my account to cover that trade, and that trade goes 100 points into loss, my account balance will be at £250. I’ve used up some of that margin.
To be precise, I’ve only got 71.4% of that margin left. At that point, I’ll probably have received a margin call from my broker.
But what happens if that trade continues to do badly? I’m now showing a loss of £175 on it. That leaves me with just £175 in my account, so I’ve eaten up 50% of that margin. At this point, my broker will automatically close out my trade due to lack of margin.
This is definitely something we want to avoid.
I’ve created a little tool which I hope will help you with working out the margin you need for your trades. You can download it by following the link below.
Bear in mind that your broker should tell you what the margin required is on a trade when you place it – so check this as you place trades.