Trading Essentials Framework Money Management …...Wise money management is the basis of any good...

Trading Essentials Framework

Money Management & Trade Sizing

™2.0

Money Management: The most critical aspect of your trading plan

Money management represents the administrative side of your trading plan.

It addresses the question of how best to use the capital available to you in the most effective manner

possible with the goal of MAXIMIZING your PROFITABILITY while at the same time PROTECTING your

CAPITAL by MINIMIZING the RISK of ruin.

The True Essence of Money Management Is Managing Risk:

Wise money management is the basis of any good trading methodology and is what ultimately will help

distinguish a consistently successful trader from the trader that consistently loses.

Many traders have fallen to the wayside trying to make a lot of money on a single trade – trying to hit that

‘home run’ – when they would have been better off making small (singles and doubles), steady

gains. Once you start doing this (and thinking this way), you will see your account consistently starting to

grow.



© Trading Concepts, Inc. 2

Money Management includes consideration of the following factors:

Deciding on the OPTIMUM amount of money to commit to any one trade relative to your total

available trading capital.

PROTECTING your PROFITS from erosion.

Avoiding (at all costs) turning a small losing trade into a huge losing trade.

If you keep your losses small, your profits don’t have to be ‘home runs’ to earn a good living.

Knowing when and how to increase the size of your cash commitment when the odds are more in

your favor (i.e. risk to reward is really tilted in your favor, etc.).

Recognizing the importance of taking some of your winnings off the table after a winning streak.

Always Know Your Exit Before You Enter

One of the cardinal rules of good trading is ALWAYS to have an EXIT point before you even enter

a trade.

If you know your initial risk, you can express all your results in terms of your initial risk.




Choosing a different E-Mini futures contracts to trade will

have a different impact your risk management strategy:

While a sound trading methodology will produce consistency in any market, a trader must consider the

volatility of each market he/she is looking to trade so as to size his/her positions accordingly based on

his/her individual risk tolerance and trading capital.

The four most popular E-Mini futures are:

the E-Mini S&P 500 futures contract,

the E-Mini NASDAQ-100 futures contract,

the E-Mini Dow, and

the Russell 2000 Index Mini futures

Trading is trading, whether one is trading the E-Mini S&P 500 or Light Sweet Crude Oil; it’s all basically the

same. However, there are some differences, such as margin, leverage, times of day the markets are open,

limit locks, and volatility. While each market does have it’s own “personality,” if you can trade one, you can

trade the other. A determining factor in which market to trade is based primarily on your individual

risk tolerance and trading capital.

If the volatility of a market is a determining factor in position sizing accordingly, how does a trader define

the volatility of a market?




What is Volatility?

Most traders will define volatility in terms of market price action.

If a market is inactive, it is considered non-volatile.

If a market is very active, it is considered volatile.

It is easy enough to look at a chart and point out a very volatile or a non-volatile market, but…

How can volatility be defined for each market?

The one thing that is directly proportional to volatility is RANGE.

RANGE is defined as the distance the price moves

(minimum price fluctuation) per increment of time

or simply the distance from the HIGH to the LOW of a

price bar.

How can volatility be defined?

Average True Range (ATR)

Average True Range is an indicator, developed by J. Welles Wilder, that measures volatility. It is

based on the high-low range of a price bar; however, it also captures volatility from a gap or

limit up/down move.

RANGE

HIGH

LOW




What are the differences across the E-Mini futures contracts

that a trader must know to position size accordingly?

In defining the volatility of a market using the Average True Range (ATR), a trader also must know the

profit/loss of each tick for each market he/she considers trading.

E-Mini S&P 500 Futures (ES)

Price Fluctuation: 0.25 index points = $12.50 profit/loss per tick size or $50 profit/loss per index point

Daily average volatility (daily ATR x index points): 24.25 index points = $1,212.50 (as of 11/30/2011)

E-Mini NASDAQ-100 Futures (NQ)

Price fluctuation: 0.25 index points = $5.00 profit/loss per tick size or $20 profit/loss per index point

Daily average volatility (daily ATR x index points): 48.50 index points = $970.00 (as of 11/30/2011)

E-Mini Dow Futures (YM)

Price fluctuation: 1 index point = $5.00 profit/loss per tick size / index point

Daily average volatility (daily ATR x index points): 221 index points = $1,105.00 (as of 11/30/2011)

Russell 2000 Index Mini Futures

Price fluctuation: 0.10 index points = $10.00 profit/loss per tick size or $100 profit/loss per index point

Daily average volatility (daily ATR x index points): 20.1 index points = $2,010.00 (as of 11/30/2011)



6

Trade Sizing

Most traders, as well as many top professional traders, do not realize the most important, non-

psychological component of trading/investing success, Trade Sizing!

A Trade Sizing Strategy:

Helps you determine how much equity to risk on every trade you take:

Its purpose is to help you meet your objectives. You could have the world’s best trading

method (for example, one that makes money 95% of the time and in which the average winner is

twice the size of the average loser), and you still could go bankrupt if you risked 100% on one of the

losing trades.

Helps you determine how much equity to risk given several inputs:

Your trading strategy’s risk, your personal risk tolerance, the kind of returns you want to

make, and your own personal definition of ruin – whether that’s bankruptcy or some level of

equity drawdown.




Trader’s

Objectives

Position

Sizing

Method

Trader’s

Psychology

3 Components of Trade Sizing



8

3 Components of Trade Sizing

1) Traders’ Objectives: everyone has different objectives when he/she trades.

You must determine what your personal objectives are.

2) Trader’s Psychology: this influences the first component (the trader’s objectives).

What are your beliefs about your trading?

What emotions come up when you’re trading?

What’s your mental state?

3) Trade Sizing Method: for a lot of traders, this is intuitive. In other words, they really don’t have an

actual method or particular algorithm.

You really need an exact method of trade sizing.

A trader with NO objectives and NO trade sizing guidelines will trade size TOTALLY by emotions.

Let me give you what I personally use…




Trade Sizing Model

A simple model for determining HOW MANY POSITIONS involves risking a percentage of your equity

on every trade. You need to know three distinct variables:

The CPR Model for Position Sizing

1. How much of your equity are you going to risk? This is your total risk, but we will call it cash (or C)

for short. This will be the C in our CPR formula. For example, if you were going to risk 2% of your

equity, C would be 2% of your equity. If you have a $25,000 account, C would be 2% of that, or $500.

2. How many units do you buy/sell (that is, what is your position sizing method)? We call this

variable (P) for position sizing method. Which futures contract are you trading and how many

contracts do you buy/sell?

3. How much are you going to risk per unit that you trade? We will call this variable (R), which

stands for risk. For example, if you’re going to buy the E-mini S&P 500 at 1239.50 and your risk is

3.00 Points or 12 Ticks (1236.50), then your risk R in this particular trade is $150. We will use this in

our CPR Formula below.

Use the following formula to determine how many contracts to trade:

P = C / R

(P) Position sizing = (C) total Cash at risk / (R) Risk (# of ticks * value of a tick)



10

Trade Sizing Model Example (P = C / R)

Let’s say, for example, with a $100,000 account balance:

You’re willing to risk 2% of your account balance ($100,000 x .02 = $2000), or C = $2000.

You BUY the E-Mini S&P 500 at 1239.50 with a risk of 3.00 ES index points, AND your broker

charges a commission of $5.00 round turn per contract, or R = $155 (3.00 ES index points x $50 +

$5.00). IF P = $2000 / $155, THEN you can trade up to 12 E-Mini S&P 500 futures contracts.

You BUY the E-Mini NASDAQ-100 at 2294.25 with a risk of 5.00 NQ index points, AND your broker

charges a commission of $5.00 round turn per contract, or R = $105 (5.00 NQ Index Points x $20 +

$5.00). IF P = $2000 / $105, THEN you can trade up to 19 E-Mini NASDAQ-100 futures contracts.

You BUY the E-Mini Dow at 12026 with a risk of 25 YM index points, AND your broker charges a

commission of $5.00 round turn per contract, or R = $130 (25 YM Index Points x $5 + $5.00).

IF P = $2000 / $130, THEN you can trade up to 15 E-Mini Dow futures contracts.

You BUY the Russell 2000 Index Mini at 725.5 with a risk of 1.7 TF index points, AND your broker

charges a commission of $5.00 round turn per contract, or R = $175 (1.7 TF Index Points x $100 +

$5.00). IF P = $2000 / $175, THEN you can trade up to 11 Russell 2000 Index Mini futures

contracts.










You BUY the E-Mini NASDAQ-100 at 2294.25 with a risk of 5.00 NQ index points AND your broker

charges a commission of $5.00 round turn per contract, or R = $105 (5.00 NQ index points x $20 +



commission of $5.00 round turn per contract, or R = $130 (25 YM index points x $5 + $5.00).



charges a commission of $5.00 round turn per contract, or R = $175 (1.7 TF index points x $100 +

$5.00). IF P = $1000 / $175, THEN you can trade up to 5 Russell 2000 Index Mini futures

contracts.

















charges a commission of $5.00 round turn per contract, or R = $175 (1.7 TF Index Points x $100 +

$5.00). IF P = $500 / $175, THEN you can trade up to 2 Russell 2000 Index Mini futures contracts.

















charges a commission of $5.00 round turn per contract, or R = $175 (1.7 TF index points x $100 +

$5.00). IF P = $250 / $175, THEN you can trade up to 1 Russell 2000 Index Mini futures contracts.




E-Mini S&P 500 (ES)

*Calculations based on $5.00 round turn per contract broker commission

1.00 Point = $50 or 1 Tick = $12.50 Profit/Loss

$7,500 Account (Risk = 2.25 ES points)

2% of $7,500 = $150 max loss:IF $112.50 Risk x 1 = $112.50 + $5* = $117.50

AND P = $150 / $117.50 (per contract), THEN

trade ONLY 1 ES contract!




trade up to 2 ES contracts!






2% of $10,000 = $200 max loss:IF $125 Risk x 1 = $125 + $5* = $130

AND P = $200 / $130 (per contract), THEN

trade ONLY 1 ES contract!









16

E-Mini NASDAQ-100 (NQ)

*Calculations based on $5.00 round turn per contract

1.00 Point = $20 or 1 Tick = $5 Profit/Loss

$15,000 Account (Risk = 22 NQ ticks)



trade up to 2 NQ contracts!












trade ONLY 1 NQ contract!








trade up to 7 NQ contracts! 17

E-Mini Dow (YM)

*Calculations based on $5.00 round turn per contract

1 Point/Tick = $5 Profit/Loss

$5,000 Account (Risk = 13 YM Points)



trade ONLY 1 YM contract!




trade up to 2 YM contracts!





$15,000 Account (Risk = 19 YM points)












18

Russell 2000 Mini Index (TF)

*Calculations based on $5.00 round turn per contract broker commission

1.0 Point = $100 or 1 Tick = $10 Profit/Loss

$10,000 Account (Risk = 2.3 TF points)



NO TRADE!




trade up to 2 TF contracts!








trade ONLY 1 TF contract!









19

Multiple Open Positions - Trade Sizing Model

Let’s say, for example, with a $50,000 account balance: You’re willing to risk 2% of your $50,000 account

balance on any one trade, and you have ONE open position. You are looking to put on another position,

and you have to assume the first open position may be a losing trade; therefore, you need to base your trade

size of the second position on an account balance of $49,000.

First trade ($50,000 x .02 = $1000) or C = $1000

Second trade ($49,000 x .02 = $980) or C = $980

Third trade ($48,020 x .02 = $960) or C = $960

First position (based on account balance of $50,000)




Second position (based on account balance of $49,000)




Third position (based on account balance of $48,020)






20

Money Management / Trading Sizing Tips

Have a written ‘trading plan’; this will help you stay focused on your goal of trading success. In

addition, it will help you learn from your mistakes and successes, which thereby will help you improve

your trading abilities as time goes by.

You should look only to take trades where there is relatively low risk compared to the reward

potential for the trade.

Always use well placed stop-loss orders; this is the only way to limit any damage to your account and

helps ensure your overall trading success.

You need to be willing to short the market as much as you’re willing to buy the market.

Never risk more than 2% of your entire account on any one single trade.

When you have a profitable month, pay yourself by withdrawing some money from your account and put

it in the bank.

Until you know your trading methodology really well, I recommend that you risk a maximum of 1%

of your entire account equity on any one position.




A Quick Word on Trader Psychology

One huge reason why successful trading can be so difficult to achieve is the emotions that are wrapped up

in the money we trade. If in our minds we are equating the money on the next trade with the money needed

for the car payment, the kids’ tuition money, or the mortgage, we may be on a sure path to trading failure. If

it is money we can’t afford to lose, it is money we simply can’t afford to trade. If we attach emotions to the

money at risk, we are much more likely to commit trading errors, which is as bad as having a bad

trading methodology to follow.

Trading Insight

Something that has had a profound effect on my investing comes from Norman Vincent Peale, author of The

Power of Positive Thinking:

"People become really quite remarkable when they start thinking that they can do things. When they

believe in themselves; they have the first secret of success."

When you feel that you actually can take control of your trading and investment destiny, the

empowerment of that control will take you to the success you are seeking.

“If you think you can...or if you think you can't...you're right.” - Henry Ford




No claim is made by the Trading Concepts, Inc. that the futures trading

strategies shown here will result in profits and will not result in losses.

Futures trading may not be suitable for all recipients of this Training

Program. All comments, trading strategies, techniques, concepts and

methods shown within our Course are not and should not be construed as

an offer to buy or sell futures contracts – they are opinions based on

market observation and years of experience. Therefore, the thoughts

expressed are not guaranteed to produce profits in any way. All opinions

are subject to change without notice. Each futures trader/investor is

responsible for his/her own actions, if any. Your purchase of the Trading

Concepts Comprehensive EMINI SUCCESS FORMULA™ 2.0 Mentoring

Program constitutes your agreement to this disclaimer and exempts

Trading Concepts from any liability or litigation.


Trading Essentials Framework Money Management …...Wise money management is the basis of any good...

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