“Everyone has a plan til they get punched in the mouth.” – Mike Tyson
Summary
1. Calculating the maximum number of losers we can sustain before our account drops below a certain minimum is instructive to determine our margin of safety for a trading system.
2. Risk on a given trade can be loosely defined as your stop loss less any commission and slippage.
3. We calculate the maximum number of losers our initial account balance can sustain by defining risk in 2 separate ways:
- Risk on a given trade is equal to a set percentage of our remaining account balance
- Risk on a given trade is equal to a certain number of ticks per trade
4. By using a fixed number of ticks per trade as our risk, we calculate the maximum number of losers before our risk exceeds 1% of our remaining account balance.
CALCULATING THE MAXIMUM NUMBER OF LOSERS IN A ROW USING A SET AMOUNT OF RISK DEFINED AS A PERCENTAGE OF ACCOUNT PER TRADE
I was reading an article over on the TradersHelpDesk.com that was discussing risk management. The premise was: “if you risked 2% of your account balance on any 1 trade, how many losing trades in a row could you sustain before you blew out your account?” Their answer was 170 trades. You can check out the article here.
So I decided to map it out. Assuming you had a $10,000 account, how many losing trades could you take IN A ROW before you blow out your account? I modeled out the amount at risk (which can be loosely defined as your stop loss plus commissions and slippage) from 1% to 10%. This was a bit of a challenge because each account never really goes to zero in this scenario. Since you are only risking a set amount of the remaining account size after the loss, the account just approaches zero. For instance, if your risk is 1% and you have an initial account size of $100, you risk $1 and lose then your remaining balance is $99. You risk 1% again or $.99 and lose then your remaining balance is $98.01. This can go on to infinity with the account never getting to zero.
But for practical purposes, we can assume that an account is totally “blown out” when the balance gets below $100. So for different sets of risk on each trade, how many losses in a row can you sustain?
Interpreting the chart, you could have 458 losers in a row if you risk 1% of your remaining account balance on each trade before your account drops below $100. You could have 227 losers in a row before your account drops below $100 if you risk 2% of your remaining account balance. This exercise is important not to show you how long you can trade before you lose it all but to show you the importance of sizing your positions. In the example above, you can take two times as many trades by risking just 1% of your account versus risking 2% of your account on each trade. This will keep you in the game a lot longer.
From a practical perspective, if you are trading futures or have a margin to satisfy, your account balance cannot drop below a certain level before your broker pulls the plug. What if we were to assume that an account of $10,000 cannot drop below $5,000. How many losing trades in a row can we have then?
Again, you can see the 2:1 relationship between risking 1% of your $10,000 account and 2% of your $10,000 account. For futures traders, risking 1% on a single E-Mini contract means that you are risking $100 or 2 points or 8 ticks. And this doesn’t include commissions or slippage. If you are thinking of risking more than 1% on any trade, you need to think long and hard if you only have a $10,000 account. You can drop below the $5,000 minimum very quickly. Scary to think that some brokers have a $500 daily minimum account balance for futures.
CALCULATING THE MAXIMUM NUMBER OF LOSERS IN A ROW DEFINING RISK AS A SET AMOUNT OF TICKS PER TRADE
One more point on the E-Mini – because tick sizes are $12.50, it is hard to dial in your risk at exactly 1%. For example, if you have the $10,000 account, risk 1% and lose, then in our example above, you should only be risking 1% of your remaining account balance of $9,900 or $99. With a tick size of $12.50, it is not possible to risk exactly $99. You have three choices at this point (other than starting with an account bigger than $10,000):
1. Add $100 of your own cash back to the account to get it to $10,000.
2. Risk less than 1% - say 7 ticks or $87.50.
3. Risk more than 1%.
A good exercise with this risk model (to keep you within the safety margin of 1%) is to look at how many trades you can have go against you in a row based on a certain tick size. We can ask two questions then:
1. How many losers in a row can you have before your account drops below a certain minimum if we are risking X number of ticks on any given trade?
We see that with a stop loss of 6 ticks, our $10,000 account can sustain 66 losers in a row before the account drops below $5,000. Our account can only sustain 49 losers in a row if we adjust the tick size to 8 ticks or $100 per contract of risk on the E-Mini.
2. If you are risking X number of ticks on any given trade, how many losers in a row can you have before the risk on any given trade exceeds 1% of your remaining account balance?
This one is an eye opener. You can’t forget when you are trading with futures the effect that leveraging has on your account. For the chart above, if we start with $10,000, and we risk 1 tick on each trade (not likely), then we can have 701 losers in a row before our next trade would have a risk greater than 1% of our remaining account balance. On our 702nd losing trade risking 1 tick (or $12.50) our remaining account balance is $1225 therefore our risk is $12.50/$1225 which is greater than 1%.
A more likely scenario is that we risk at least 6 ticks on the trade, which gives us 34 losing trades in a row before we have a risk on our remaining account balance of greater than 1%. On our 35th losing trade risking 6 ticks (or $75.00) our remaining account balance is $7450 therefore our risk is $75.00/$7450 which is greater than 1%.
The likely answer to this problem is to up the size of our initial account. It is more likely, considering slippage and commissions, that our risk on a given trade will exceed 6 ticks. What if we started with an account balance of $20,000?
This is a little better. If our risk per trade is 6 ticks, then we can have 167 losers in a row before the next trade has a risk that is greater than 1% of our remaining account balance. If we did have 167 losers in a row, then our remaining account balance would be $7475 (167 Losers X $75 Risk Per Trade = Loss of $12,525). Our risk on the 168th trade would be defined as $75/$7475 so our risk would be greater than 1%.
SUMMARY
The point of this exercise is to keep you in the game. We can’t predict how many losing trades we are going to have in a row. We can control our risk every time we put on a trade though. As a new trader, you have to give yourself a margin of comfort. Ask yourself, is it likely that I will have X number of losers in a row? If I did, how long could I trade my account? The charts above should help you out as a starting point.
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