Risk Too Much and You Will Lose

I've been slowing getting my Forex "legs" back by reading a book I picked up months ago.  The Book is called "Trade Your Way To Financial Freedom" by Van K. Thorp.  I picked it up months ago based on recommendations from Simon over on his blog.  I can see why he thinks so highly of this book because it is so different from the plethora of trading books out there.  Van stresses managing reward to risk in your trades and position sizing.  I was certainly most interested in his position sizing chapter of which I'll be talking about more in the future. 

Poor position sizing can kill your account.  Risk too much on any given trade and it could be impossible to recover.  I've been down this road before and the reasons for this were inexperience and greed.  If you were to open a $1000 trading account and you lose $200 on your first trade, this would be a 20% drawdown.  The percentage gain you need to recover from this loss is a possibly manageable 25%.  But if you were to lose $400 on your first trade, or a 40% drawdown, you would need a 66.7% gain to recover from this loss.  This information may be trivial and known by many, but the extent isn't quite noticeable until you see the following table.   Losses beyond 50% require "huge, improbable gains in order to get back to even."

Recovery after Drawdown

 Drawdowns, % Gain to Recovery, %
 5 5.3
10 11.1
15 17.6
20 25.0
25 33.0
30 42.9
40 66.7
50 100.0
60 150.0
75 300.0

Comments

9 Responses to “Risk Too Much and You Will Lose”

  1. Forex Trader on October 22nd, 2007 3:28 am

    Rob Booker recommends not to risk more than 25% on any given trade. I think this is a bit much though… any thoughts?

  2. Forex Trader on October 22nd, 2007 2:12 pm

    In that book, Tharp hits again and again on the idea that the single most important thing one can do is to cut one’s losses short and let the winners run. This is the exact opposite of the strategy you propose here. Is Tharp wrong?

  3. Rich on October 22nd, 2007 8:04 pm

    I personally think risking a quarter of your balance on 1 trade is crazy. I risk at the most 3% which I’ve even heard is too much.

  4. Rich on October 22nd, 2007 8:05 pm

    I’m not proposing a strategy here. This is directly from Tharp’s book but like I said, is not a strategy, just a chart of how much you need to recover if your drawdown is a certain percentage.

  5. Cathy on October 23rd, 2007 9:18 am

    Rob Booker recommends risking no more than 1% on any given trade, not 25%.

  6. Rob Booker on October 23rd, 2007 9:42 am

    Yeah, it’s no more than 1% per trade. And if you go past losing 25% of your account (on any series of trades) that you stop completely and not trade again, at all, period, until you’ve been able to work and save money to put back into your trading account, and gotten some help, and done research and study money management, just like our friend from Forex Project is doing here. It’s simply not possible to study and learn too much about risk management. Van Tharp’s book is good; The Handbook of Portfolio Mathematics is good too.

    I also just read that this is NOT a discussion thread. And that I needed to keep my comments brief. Sorry about that.

  7. James Woolley on October 24th, 2007 6:42 am

    I personally risk no more than 10% of my bank at the very most, but risking 25% is just asking for trouble.

  8. Forex Trader on October 24th, 2007 11:00 am

    Thanks a lot for this information. I come across too many beginners that try to risk too much. I will recommend this post to everyone that I know that wants to get involved in FOREX trading.

  9. Forex Trader on October 24th, 2007 1:56 pm

    My forex edge offers a program that allows you to pick the % of the trade, the ratio’s of risk and reward as well as instant lot allotment information. I think the above is crucial for long term profits. 5% should be max…

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