Trading with an edge

[Aaron137]

While browsing at the bookstore I had a chat with a guy who bets 5% for a 2.5% return. The question I didn't ask was the percentage of winning / losing trades over the long run. Some people advocate risking 1-2% of trading capital on each trade, but if you know what you long term performance is, 5% or more may be better.

In the above case, let's say the reward to risk is: 0.5 to 1. Futhermore you win 60% of trades. To work out the ideal % to risk, you would take the losing % (40%) and divide by 0.5, giving you 80% - so 60% less 80% is minus 20%. Clearly an unfavourable proposition.

On the other hand 70% to 30% win / loss: 30% / 0.5 = 60%. 70% - 60% = 10%. So the ideal risk amount in this case is 10% of equity.

This is based on my interpretation of the kelly formula. If you wanted to play safe, risk half the 10% edge, or 5%.

It seems people can make money with only a 30% success rate. i.e. reward being 3 to 1 - approx. a 6% edge. A 2 to 1 reward on the other hand would be -5%.

Does anyone use this in their calculations of 'how much' to risk on a trade? Or is 1-2% more common?

[mikeyo308]

A lot of it depends on the situation. If you make 12 trades a year, you can justify using a higher risk. If you're doing a half a dozen trades a day, you should be risking a very small percent of your capital per trade (i.e.1% or less). You just have to find out what works for you and your strategy. Right now, I'm trading about 0.6% of my account per trade, with 1-6 trades a day. And I look to get at least 2:1 reward:risk. That way I can preserve my capital and not get wiped out with a string of bad days.