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     sway
Member
Username: sway
Post Number: 11
Registered: 12-2005Rating: N/A
Votes: 0
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| | Saturday, January 13, 2007 - 04:54 pm: |  
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Hi
I'm a long term IC user and eager forum reader, but an infrequent poster.
My question relates to the term "Trading Capital". Let's call it TC for short. There is an often repeated risk management rule that you should never risk more than 2% of your TC on any one position. I assume that TC means the current market value of all of your positions plus any cash you have in your trading account.
But what happens if you have a margin loan? For example, if you have a $200k portfolio made up of $100k of your money and $100k borrowings (ie loan ratio), is your TC $100k or $200k? Coming back to the 2% risk rule, I can think of arguments for both definitions of TC.
What is the consensus on this?
Thanks
Geoff
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sway
Member
Username: sway
Post Number: 12
Registered: 12-2005Rating: N/A
Votes: 0
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| | Saturday, January 13, 2007 - 11:16 pm: |
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small correction:
... and $100k borrowings (ie loan ratio is 50%), is your TC $100k or $200k? .....
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peter1
Member
Username: peter1
Post Number: 151
Registered: 12-2005Rating: N/A
Votes: 0
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| | Sunday, January 14, 2007 - 01:56 pm: |
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If you intend to invest the whole 200K then your TC is 200K.
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wadda
Member
Username: wadda
Post Number: 340
Registered: 10-2002
Rating: N/A
Votes: 0
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| | Sunday, January 14, 2007 - 02:55 pm: |
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Sway,
A cautious approach to the borrowed money maybe to reduce the 2% per trade.
I have real shares (2% risk per trade) and CFDs using 1-1.5% per trade. Still figuring a happy mix for risk management though - just a suggestion.
wadda
"Buy low, sell high is a cliche, not a blueprint for action. It blinds investors to the professionals' approach of buying high and selling higher." Stan Weinstein
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sway
Member
Username: sway
Post Number: 13
Registered: 12-2005Rating: N/A
Votes: 0
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| | Sunday, January 14, 2007 - 05:37 pm: |
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Thanks Peter1 and wadda. I have been stopped out on a few E*Trade conditional orders (trailing sell) lately, and yes, I also think 2% is a bit too high. I am experimenting on a spreadsheet trying to balance the risk against ATR, position size and number of positions. All the while looking at past support levels. I find that setting stop losses is one of the more difficult judgements you have to make.
Everyone feel free to add your thoughts.
Thanks
Sway
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chart_rider
Member
Username: chart_rider
Post Number: 202
Registered: 01-2005Rating: N/A
Votes: 0
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| | Sunday, January 14, 2007 - 09:14 pm: |
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sway
The 2% rule defines a safe level of exposure, to permit a run of losses without destroying a trading account.
If you leverage 100k to 200k, does this mean that suddenly 4% ($4,000) of your cash base can be safely risked on each trade?
What about if the account was leveraged from 100k to 1m, would it be safe to risk 20k on each trade, with a total base cash risk of 100% if 5 positions were held?
You must feel comfortable with the answers to these questions.
CR
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lafee
Member
Username: lafee
Post Number: 269
Registered: 04-2003
Rating: N/A
Votes: 0
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| | Sunday, January 14, 2007 - 09:47 pm: |
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A big ship has many compartments so that if one part of the ship starts taking on water it cannot flood the entire ship and make it sink. I like to structure my trading in a similar fashion. I allocate funds to a each system I create and compound each system independently. Generally I don't risk less than 10% of a "compartment" on each trade.
I sometimes incorporate more than one system into each compartment depending on how correlated I believe my systems are. By approaching the problem this way I find that I can get the benefits of aggressive compounding with the safety of diversification and do away with price based stops altogether.
Cheers
Lafee
If nobody can be certain of anything, how can I be certain of that?
Ayn Rand
When I was young people called me a gambler. As the scale of my operations increased, I became known as a speculator. Now I am called a banker. But I have been doing the same thing all the time.
Ernest Cassel
"My major hobby is teasing people who take themselves & the quality of their knowledge too seriously & those who don’t have the guts to sometimes say: I don’t know...." (You may not be able to change the world but can at least get some entertainment & make a living out of the epistemic arrogance of the human race).
Nassim Nicholas Taleb
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ken
Member
Username: ken
Post Number: 435
Registered: 04-2003Rating: N/A
Votes: 0
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| | Tuesday, January 16, 2007 - 08:56 am: |
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Capital is capital, not borrowings. It is the nett amount you have. Hence the 2% is of the amount you own, not of the amount you have to trade with. You can take something like 190 losing trades at 2% loss of capital before you wipe out, but much less at higher losses.
I always got into trouble and lost more than I wanted to when I took the opposite approach.
Trade more positions of the same loss per trade if you must. Your psychology will be affected if you allow too much loss and you will not trade effectively if a large loss is weighing on your mind.
Ken
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sway
Member
Username: sway
Post Number: 14
Registered: 12-2005Rating: N/A
Votes: 0
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| | Tuesday, January 16, 2007 - 11:14 pm: |
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Thanks for the replies.
Nice analogy Lafee.
chart_rider and ken:
It seems there are opposing views here. After thinking a bit more, I'm tending to the view that you are managing the risk of all the money you have in the market, so it doesn't matter whether it is yours or the lenders - you are responsible for it anyway. You are still trying to manage risk on $200k, using the same principles you would on $100k or $1,000k.
Thanks again
Sway
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staybaker
Member
Username: staybaker
Post Number: 50
Registered: 03-2003Rating: N/A
Votes: 0
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| | Thursday, January 18, 2007 - 09:16 pm: |
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"After thinking a bit more, I'm tending to the view that you are managing the risk of all the money you have in the market, so it doesn't matter whether it is yours or the lenders"
Nope, if you lose all of your own money then that's unfortunate because you're out of the game, but at least it ends there. But if you lose the lender's money, they will come after you ... you may lose your house, your car, your [insert whatever is important to you here]. I think it matters considerably whose money you are losing.
I asked the same question on this forum a few years ago, and received conflicting opinions. My conclusion was that you should evaluate your risk relative to your own funds (i.e. not including the borrowed money). In order to take advantage of the borrowings, therefore, you need to take additional positions. This reduces your overall risk due to diversification across more stocks, but increases your exposure to market risk (i.e. the risk that the market and all your positions will tank at the same time).
Hope this helps,
Cheers, Staybaker. 
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sway
Member
Username: sway
Post Number: 15
Registered: 12-2005Rating: N/A
Votes: 0
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| | Thursday, January 18, 2007 - 10:05 pm: |
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Staybaker
Yes, it does help. Thanks for the reply. I'm not totally convinced, but at least it has made me think a lot about risk.
Sway
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