Capital management in trading

Basic concepts of capital management in trading Capital management or risk management is one of the determining factors of success or failure in financial markets. Capital management means controlling and protecting your capital against possible losses and increasing your profits by using methods and rules that are scientifically and logically determined based on market conditions and trader personality. In this article, we will examine some basic concepts of capital management in trading.

Position Size:

Position size is the amount of capital that a trader invests in a specific trade. size should be calculated based on the acceptable risk level and stop loss of the trade. As a general rule, it is recommended that you never risk more than 1 to 2 percent of your total capital in a trade. To calculate the position size, you can use the following formula:

Position Size=Risk AmountStop LossPosition Size=Stop LossRisk Amount​

where:

• $\text{Risk Amount}$: The amount of capital that you want to risk in a trade. Usually equal to 1 to 2 percent of the total capital.
• $\text{Stop Loss}$: The distance between the entry price and the stop loss price. Stop loss is a price that closes your trade and limits your loss if it is reached.

For example, suppose your capital is 10,000 dollars and you want to participate in a trade with an entry price of 100 dollars and a stop loss of 90 dollars. If you want to risk 1 percent of your capital, your position size will be equal to:

Position Size=10,000×0.01100−90=10Position Size=100−9010,000×0.01​=10

This means you can buy 10 shares of this stock. In this case, if the price reaches your stop loss,

your loss will be equal to:

$$\text{Loss}=10\times (90-100)=-100$$

which is equal to 1 percent of your capital.

Risk to Reward Ratio: Risk to reward ratio indicates how much your expected profit is more than your allowed loss. For example, if your stop loss is 10 dollars and your target profit is 30 dollars, your risk to reward ratio will be equal to:

Risk to Reward Ratio=RewardRisk=3010=3Risk to Reward Ratio=RiskReward​=1030​=3

This means that for every dollar you risk, you make three dollars of profit. Generally, your risk to reward ratio should be more than 1 to 1 for your trades to be profitable. To calculate the risk to reward ratio, you can use the following formula:

Risk to Reward Ratio=Target Price−Entry PriceEntry Price−Stop LossRisk to Reward Ratio=Entry Price−Stop LossTarget Price−Entry Price​

where:

• $\text{Target Price}$: The price that you want to close your trade and collect your profit. Equivalent to the target profit.
• $\text{Entry Price}$: The price that you enter the trade.
• $\text{Stop Loss}$: The price that you close your trade and limit your loss if it is reached. Equivalent to the stop loss.

For example, suppose your entry price to the trade is 100 dollars, your stop loss is 90 dollars and your target profit is 130 dollars. In this case, your risk to reward ratio will be equal to:

Risk to Reward Ratio=130−100100−90=3Risk to Reward Ratio=100−90130−100​=3

This means that for every dollar you risk, you make three dollars of profit.

Trading Plan in Capital management in trading:

Trading plan is a document that includes your strategy, goal, method, and rules of trading . plans helps you align with your objectives and avoid random and irrational trades. plan should be based on market analysis, personality, and level of experience and should be regularly reviewed and updated. Some of the items that you should consider in your trading plan are:

Overall goal:

What is your overall goal in trading? For example, do you want to use trading as a primary or secondary source of income? Do you want to use trading as a hobby or a challenge? Do you want to use trading as a way to increase your knowledge and experience? Your overall goal should be clear, measurable, and aligned with your expectations and capabilities.

 Monthly and weekly goals:

Your monthly and weekly goals indicate how much profit or loss you want to achieve within a specific period.  monthly and weekly goals should be based on your capital, risk, return, and the number of trades you make. Your monthly and weekly goals should be reasonable and achievable without putting undue psychological pressure on you. Also, you should regularly review and evaluate your monthly and weekly goals and make changes if necessary.

Trading strategy:

Your trading strategy shows how you seek trading opportunities and how you enter and exit trades. Your trading strategy should be based on your technical analysis, fundamental analysis, psychological analysis, and capital management analysis. trading strategy should be simple, clear, and executable, and should be in line with your trading personality and style. Additionally, you should regularly test and improve your trading strategy.

Trading rules:

trading rules indicate what actions you should and should not take. Your trading rules should be based on capital management principles, position size, stop-loss, take-profit, risk-to-return ratio, entry and exit times, markets and trading instruments, trading days and hours, and other factors related to trading. Your trading rules should help you avoid negative emotions such as greed, fear, hope, and regret in trading decisions and make logical and disciplined decisions.

Different methods of capital management in trading

management in trading is one of the determining factors of success or failure in financial markets. Capital management means controlling and protecting your capital against potential losses and increasing your profits using methods and rules that are determined scientifically and logically based on market conditions and the trader’s personality. In this article, we will examine several different capital management methods in trading.

Fixed Fractional Method:

This method is one of the simplest and most popular capital management methods in trading. In this method, you risk a fixed percentage of your capital in each trade. For example, if your capital is $10,000 and your risk percentage is 2%, you would risk $200 in each trade. This method allows you to increase the size of your trades as your capital grows and decrease the size of your trades as your capital decreases. This method helps you resist losing streaks and prevent stress.

Fixed Ratio Method:

This method is one of the more advanced capital management methods in trading. In this method, you risk a fixed amount of your capital in each trade, but this fixed amount increases with the growth of your capital. For example, if your capital is $10,000 and your fixed amount is $200, you would risk $200 in each trade. However, if your capital reaches $20,000, your fixed amount would increase to $400. This method allows you to increase the size of your trades proportionally as your capital grows and decrease the size of your trades proportionally as your capital decreases. This method helps you take advantage of better market opportunities and maximize your profits.

Kelly Criterion Method:

This method is one of the most complex and risky capital management methods in trading. In this method, you risk a variable percentage of your capital in each trade. This variable percentage is calculated based on the probability of winning, the probability of losing, and the risk-to-reward ratio of the trade. For example, if your win probability is 60%, your loss probability is 40%, and your risk-to-reward ratio is 2, your risk percentage would be calculated as follows:

Risk Percentage = Win Probability × Risk to Reward Ratio – Loss Probability
Risk Percentage = 0.6 × 2 – 0.4 = 0.8 – 0.4 = 0.4
This means you should risk 40% of your capital in each trade