You have a limited amount of money for trading whether it is $1,000 or $1,000,000, once it's gone, you are done with trading. The problem is that you can have a long string of losing trades before you hit a winner with your trading system.
The riskier you're trading strategy, the more thought you need to give to your money management style. Otherwise, you can find yourself out of the market with a margin call in no time. Let's say, you trade 100% of your account. You only need one losing trade to lose 100% of your account. Suppose, you divide your trading account into 10 equal parts. Now, you can have 10 losers before you are out of the market.
Now, if you divide your account into 100 equal parts, you need 100 losing trades to call it a day as a trader. This is idea behind the famous Kelly Criterion. You need to trade only a fraction of your trading account let's say not more than 2% on each trade. You got the idea, good money management can keep you in the game so that eventually you start hitting winners.
But there is always a trade off. Remember the most important rule in finance, "no risk, no return." In other words, the more return you want, the more risk you will have to take. But how much you should risk to get a decent reward? This is the most important thing for you. You don't want to risk everything of course. So you don't want to risk everthing on a single trade as long as there is some risk of losing your money. But at the same time you want a decent return to make in your trading otherwise there is no purpose of trading. So, how to go about it.
So what you need is a good money management system that tells you the position size for each trade that you should bet. Kelly Criterion emerged from the work done on signal noise issues in 1950s in the famous Bell Labs. Very soon, the mathematicians who had developed this formula saw its' application in gambling and trading and in no time this formula took off with the traders.
What you need to do is first select a trading system that you think you will use in your trading. Now make a number of trades with that trading system something like 30-40 trades. Use the data from these 30-40 trades to calculate the ratio of winning trades to the losing trades made by that trading system. Also calculate the average return on a winning trade plus the percentage of winning trades that the trading system makes. Now use this formula to calculate the Kelly Ratio: Kelly %age=W-{(1-W)/R}. This ratio will tell you the percentage of your trading account that you can risk on a single trade using that trading system.
W is the percentage of winning trades that the system makes over time. R is the average gain of the winning trade over the average loss of the losing trade. Many traders divide this percentage by 2 to be on a more safe side.
SOURCE:
http://www.articlesnatch.com/Article/Risk-And-Money-Management-In-Trading-With-The-Kelly-Ratio/965486
The riskier you're trading strategy, the more thought you need to give to your money management style. Otherwise, you can find yourself out of the market with a margin call in no time. Let's say, you trade 100% of your account. You only need one losing trade to lose 100% of your account. Suppose, you divide your trading account into 10 equal parts. Now, you can have 10 losers before you are out of the market.
Now, if you divide your account into 100 equal parts, you need 100 losing trades to call it a day as a trader. This is idea behind the famous Kelly Criterion. You need to trade only a fraction of your trading account let's say not more than 2% on each trade. You got the idea, good money management can keep you in the game so that eventually you start hitting winners.
But there is always a trade off. Remember the most important rule in finance, "no risk, no return." In other words, the more return you want, the more risk you will have to take. But how much you should risk to get a decent reward? This is the most important thing for you. You don't want to risk everything of course. So you don't want to risk everthing on a single trade as long as there is some risk of losing your money. But at the same time you want a decent return to make in your trading otherwise there is no purpose of trading. So, how to go about it.
So what you need is a good money management system that tells you the position size for each trade that you should bet. Kelly Criterion emerged from the work done on signal noise issues in 1950s in the famous Bell Labs. Very soon, the mathematicians who had developed this formula saw its' application in gambling and trading and in no time this formula took off with the traders.
What you need to do is first select a trading system that you think you will use in your trading. Now make a number of trades with that trading system something like 30-40 trades. Use the data from these 30-40 trades to calculate the ratio of winning trades to the losing trades made by that trading system. Also calculate the average return on a winning trade plus the percentage of winning trades that the trading system makes. Now use this formula to calculate the Kelly Ratio: Kelly %age=W-{(1-W)/R}. This ratio will tell you the percentage of your trading account that you can risk on a single trade using that trading system.
W is the percentage of winning trades that the system makes over time. R is the average gain of the winning trade over the average loss of the losing trade. Many traders divide this percentage by 2 to be on a more safe side.
SOURCE:
http://www.articlesnatch.com/Article/Risk-And-Money-Management-In-Trading-With-The-Kelly-Ratio/965486
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