Day trading strategies: the complete guide with all the advanced tactics for stock and options trading strategies. Find here the tools you will need to invest in the forex market

CHAPTER 3:
 
 
Quantitative Risk and Qualitative Risk
hen talking of risk, we can divide it into two broad groups:
quantitative risk and qualitative. By nature, the quantitative
risk is easier to measure and track because a lot of it is just
numbers. The most basic is your hit rate and payout ratio.
To get a better idea of your risk, though, you should be tracking the
following at a minimum. These numbers will also help clarify the
profitability of a strategy, so when you back-test something, make sure to
run these numbers as well.
 Average Risk Percentage 
This is the percentage of your account you are risking per trade. Now,
you’ll find a lot of sources online saying you should not risk anything over
2% of your account. Personally, I find 2% ridiculously high for beginners.
Think of it this way. If you risk 2% per trade, after taking ten losses in a
row, you’ll be 20% underwater! Imagine investing your money in
something and losing 20%! You might think it’s unlikely that ten losses in a
row will occur, but this is ignoring the odds.
Based on your hit rate, your strategy will have certain odds of losing streaks
based on their size. So the odds of a 10-trade losing streak for a 35% hit rate
strategy, theoretically, are 91%. In other words, extremely damn likely.
Your objective should be to protect your capital at all costs. Therefore,
risking 2% when you have a 91% chance of experiencing a 20% drawdown

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(more on this below) is doing the exact opposite. As a beginner, your risk
per trade should not be more than 0.25% of your account. This way, if you
lose ten in a row, which is very likely, you’ll be down just 2.5%, which is
easily retrieved.
Drawdown 
A drawdown is just the size of the loss you take, so if you lose a trade and
are risking 0.25% per trade, your drawdown is 0.25%. More relevant is the
max drawdown, which is what most traders refer to when reviewing a
strategy’s effectiveness. The max drawdown is the difference between the
highest and lowest points of your account’s equity curve.
So if you lost 10 or 20 trades in a row, your account’s equity graph is going
to dip. The difference between the start of the dip and the trough or bottom
is the total drawdown. The max drawdown is the biggest total drawdown
the strategy experiences.
Drawdown size is a function of the hit rate and the per-trade risk. A strategy
with a high hit rate can still experience significant drawdown if the per-
trade risk is high.
As a reference, if you have a drawdown of over 10%, your account is 99%
unlikely to recover. In the professional world, any fund that loses 10% is
simply shut down since the managers are unlikely to recover the amount,
and it’s just more profitable to shut down and open a new fund. For
professional traders who can be fund managers or prop shop traders, a
monthly drawdown of 2% is the limit for the former and 4% for the latter.
Now, those numbers are for professionals, and as a beginner, you should
stick to the 2% goal. In other words, you should structure your per-trade
risk in a way that it is remotely possible for you to hit the 2% even with a

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very probable losing streak. This is how you take care of the downside and
let the upside take care of itself.
As you can imagine, risking 0.25% per trade is unlikely to get you rich
quick or provide enough income for you to quit your job and give everyone
the middle finger. If you’re disappointed or feel let down by this, I suggest
you read the introduction again to understand what trading is really about.
You’ll save yourself a lot of time by trying to understand whether it really is
for you or not.