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Money Management Methods in Stock Indices Trading

In stock indices there are two money management methods commonly used to manage the account capital in a traders account.

 

The two money management methods are:

1. Risk: Reward Ratio

2. Percentage Risk Method

 

Risk: Reward Ratio

The risk: reward ratios means that as trader you only trade when you are likely to make more profits, for example if you have a risk: reward ratio of 3:1 then it means that you will only trade when you are likely to make profits 3 times as compared to not making profits.

 

Or put in another way you are more likely to make 3 times what you risk in a single trade. This means that if you risk $100 then you are likely to make $300 dollar in profit on that trade.

 

Having a high risk: reward ratio will improve your chances of making more profit when trading the stock indices market, for example even if your system win rate is 50 % or even 30 %, you will still make profits if you have a good risk: reward ratio as shown in the illustration below:

 

 

From this example if your trade system win rate is 50 % and your risk reward is 3:1 then from ten trades that you will have made your profit would have been $10,000 dollars, even if your trading system win rate was lower than this and for example your win rate was 30 % you still would have made a profit of $2,000 from the few winning trades as shown above.

 

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Percentage Risk Method

This method a trader will set a fixed percent to risk per trade, therefore a trader may decide to risk only 2 % per trade, this way their risk is always kept to a minimum.

 

Therefore if a trader has a $50,000 dollar account, the amount to risk per trade is about $1,000 dollars, therefore depending on the trade transaction open a trader will set the stop at this amount of $1,000 dollars:

 

For example:

If the trader opens is trading the Italy FTSE MIB 40 or IT40Cash which has a pip value of 1 and one pip move is equal to 1 point then the trader would calculate the percent risk money management depending on the trading lots opened as shown below

 

Example 1:

If the trader opens 1 Lot and 1 point move is equal to 1 which is equal to $1.2, then the trader would calculate the points where to place a stop on their trade as shown below:

 

1 Lot equals 1 per 1 pip move ($1.2)

$1,000 dollars/$1.2 (1 is equal to $1.2) equals 833 points

The trader would set their stop 833 pips away

 

Example 2:

3 Lots equals 3 per 1 pip move ($3.6)

If the trader opens 3 Lot and 1 point move is equal to 3 which is equal to $3.6, then the trader would calculate the points where to place a stop on their trade as shown below:

$1,000 dollars/$3.6 (3 is equal to $3.6) equals 277 points

The trader would set their stop 277 pips away

 

Example 3:

5 Lots equals 5 per 1 pip move ($6)

If the trader opens 5 Lots and 1 point move is equal to 5 which is equal to $6, then the trader would calculate the points where to place a stop on their trade as shown below:

$1,000 dollars/$6 ( 5 is equal to $6) equals 166 points

The trader would set their stop 166 pips away

 

Example 4:

10 Lots equals 10 per 1 pip move ($12)

If the trader opens 10 Lots and 1 point move is equal to 10 which is equal to $12, then the trader would calculate the points where to place a stop on their trade as shown below:

$1,000 dollars/$12 (10 is equal to $12) equals 83 points

The trader would set their stop 83 pips away

 

This also means the less the lots a trader opens, the more the pips a trader has when it comes to setting the stops. If a trader opens 1 lot then he can set the stop up to 833 pips and still be within the 2 % percent risk rule, while if the trader opens 10 lots then they will have to set the stops at only 83 points away so as to be within the 2 % risk management rule.

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