Trade Stock Indices

Money Management Techniques - Index Money Management Strategies Methods

There are two prevalent money management techniques typically employed for managing a trader's capital.

The two funds management strategies are:

1. Risk: Reward Ratio

2. Percent Risk Strategy

Risk: Reward Ratio

Risk:reward ratios dictate that a trader should only enter trades where potential profits outweigh the risk. As an illustration, a 3:1 risk:reward ratio implies you will only trade if you anticipate profits three times greater than the potential loss.

In other terms, you are likely to earn three times your risk with a single trade. This implies that if you risk $100, your expected profit could be $300.

Having a high risk : reward ratio will improve your chances of making and earning more profits when trading the market, e.g. even if your system win ratio is 50 % or even 30 %, you'll still make profits if you have a good risk: reward ratio such as displayed and shown in the illustration below:

Money Management Methods - Stock Index Money Management Strategy

From this example if your system win ratio is 50 % & your risk reward is 3:1 then from ten trade transactions that you will have made your profit would have been $10,000, even if your 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 is shown above.

Percentage Risk Method

An index trader sets a fixed percent to risk on each trade. For example, they might limit it to 2 percent. This keeps overall risk low.

Say an index trader has $50,000. Risk $1,000 per trade. Set stops at that level based on the entry.

For illustration:

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

Example 1:

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

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

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

The trader would set their stoploss 833 pips away

Example 2:

3 Lots equals € three per 1 pip movement ($3.6 dollars)

If a trader takes three lots and one point equals three euros, or about 3.60 dollars, they set stops at key points like this.

$1,000/$3.6 (€ 3 is equivalent to $3.6) equals 277 points

One would set their stoploss 277 pips away

Example 3:

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

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 and set a stop on their trade as is shown:

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

The trader would set their stoploss 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 and set a stop on their trade such as shown below:

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

One would set their stoploss 83 pips away

This also means that when a indices trader opens fewer lots, they will have more pips for setting the stops. If a trader opens 1 lot, they can set the stop up to 833 pips and still stay within the 2% risk rule, but if the trader opens 10 lots, they must set the stops only 83 points away to stay within the 2% risk management rule.

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