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Alex wrote:
> I don't know anybody who says stops should be placed such that 2% of
> your equity is being risked. Rather, stops should be placed sensibly
> according to your trading strategy, and it's your responsibility to
> ensure that you have sufficient equity in your account to accomodate
> that risk at a 2% level or less.
Exactly. Let's get the horse in front of the cart.
Your stop should be based on what the market is doing. Volatility is one
such measure but there are others depending on your system. You should
thoroughly backtest where the stop should be set, e.g. X standard
deviations or Y ATRs, to maximize some performance measure such as the
Sharpe ratio. Then, how many contracts you trade, both in the backtest
and in real trading, is based on the size of the stop so you are only
risking a certain percentage of your account. Again, that safe
percentage needs to be tested, e.g. with a Monte Carlo sim, to see how
much you can risk on each trade and still avoid going broke. "Rules of
thumb" such as 2% aren't very useful. You need to determine your own
percentage for your own system and your own risk tolerance.
So, short version:
1. The stop comes first based on the market.
2. Then you determine your size based on the stop, your account size and
your risk tolerance.
3. 1 and 2 have been thouroughly backtested and simulated so you aren't
guessing or using rules of thumb. Of course, there are no guarantees in
the future but it helps a lot to have hard numbers estimating your risk
of going broke instead just of a vague gut feeling.
This game is about survival, not getting rich. :-)
--
Dennis
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