davkell

With reference to medium term trading, I've arrived at the same conclusion as you.  I considered the following scenario:

A trader has set a risk limit of 2% of total equity per trade, and a SL level of 5% for each position.

Lets say the trader has $10,000 equity, then the allowable risk for one position is $10,000 x 2% = $200.  Now, $200 / 5% = $4000, so $4000 can be pumped into each position.  Lets say the trader wishes to hold a maximum of 5 open positions concurrently, then the total portfolio is $20,000, leading to 50% margin.  The maximum amount of equity at risk at one time is 10%.

50% margin could be done either with CFD's or buying shares directly with margin loan facility.

Chart Rider

Cobra

It sounds like your trading is based upon quite a short term style, perhaps of a few days or so?

I used to trade based upon price action between straight edge trend bands, with trades being of a few days duration.  For a variety of reasons, I modified my strategy a few months ago to 10 day/20 day EMA cross-overs, with the view of trades lasting several weeks (straight edge trends lines still form a secondary indicator in my strategy).  In both cases, however, the stop loss remains at a few percent and is triggered by price action.  For a stock that slowly drifts down (or sideways) the MA cross will trigger a "controlled" exit, but a sudden price movement will still trigger an instantaneous stop loss.  I base the stop loss on percent as from back testing I have found consistency with using  4 - 5 % (setting it tighter reduces overall return just as dramatically as loosening it up).  This provides me with a simple solution, no support line or soul serching required.

The same could be applied with placing a stop loss below a MA, as in the previous example - any sudden price movement below the MA will trigger an exit, not to be confused with waiting for the MA to drop below a certain point.

Although I trade shares direct, where the level of margin is less than with CFD's, the strategy remains the same. The tricky question is whether placing a limit of 2% of total trading capital at risk applies to 2% of base capital or 2% of capital including margin.

Initially my thoughts were that it should be based upon total buying power, but I may have been wrong here, consider this example:

Lets say a person has $100,000 in the bank to trade with, and 5 trades in a row hit the stop loss, then the damage will be:

1st trade - 2% of $100,000 = $2000 loss

2nd trade - 2% of $98,000 = $1960 loss

3rd trade - 2% of $96,040 = $1920 loss

4th trade - 2% of $94,120 = $1882 loss

5th trade - 2% of $92,238 = $1844 loss

Adding to a total loss of $9606, leaving the trader with $90,394 to continue trading.

Another trader has $10,000 and trades on 10% margin, so the total buying power is $100,000.  Thus, 5 losses in a row will again lead to $9606 loss. In this case though, the trader has lost nearly all the base capital and so basically cannot continue trading.

Clearly my response a couple of days ago is flawed, is the answer then somewhere in between?

Chart Rider

Making a little sense. The hardest thing about stop losses and profit taking exits is when studying the best option you're always looking in hindsight. This makes it extremely hard to make a firm decision as to what stop you want. But I guess that is the art of trading as some say!

Will look into CFD's a little more closely and see if I can amend my system to suit.

Thanks for the responses. Keep em coming if you have anything further to add.

davkell

The 2% of trading capital is a figure devised to ensure the ability to continue trading after a series of losing trades. As such it should, in my belief, be considered with reference to your total purchasing power.

Thus, if your trading CFD's, or any instrument, on a margin of 10% (for example), then with $5000 base capital your purchasing power is $50,000.  Personally I find 2% to be beyond my pain barrier and I prefer to work within 1%, there have been times I have dropped right down to 0.5%.

Even if you work on 0.5%, with a purchasing power of $50,000 this equates to $250 which should permit reasonable trade sizes.

I agree with Cobra, 8%  is quite a loose stop loss.  I tend to use around 4 - 5% and to observe this often means passing up on a trade if the price rises too quickly. In my case I structure my trades around the 20 day EMA and place a limit that say's I can buy only if the price is no more than 4% above the MA.  By doing this it is possible to keep tighter stop losses and prevents me from chasing prices.

In your example then, lets say 5.77 was 2% above the 26 day EMA and you place a stop 2% below the MA, then your stop will be sitting at 5.54.  If you selected 0.5% of your purchasing power as the maximum loss size, which equates to $250, then your trade size will be 250 / (5.77 - 5.54) = 1086 shares, which is a reasonable size trade.  With 10% margin this will cost $626, which is about 1/8 of your bank roll - also reasonble.

Does all that make sense?

Chart Rider

Hi Cobra;

My 2% is based on Trading Capital, in this case $5000. Not a great ideal, but that is what I've got to play with unfortunately.

My stop loss figure is based on the 26week EMA of the previous bar.

So yes you're correct, individual trades which are stopped out would be in the range of 15-20% trade losses, but only 2% loss to my overall capital. (Brokerage I calculate as a separate cost at this stage in my trading.) What I'm trying to work out, is how to use CFD's but keep my losses to 2% of trading capital and still utilise the same stop loss level.

davkell,
Firstly, I would think a stop loss of $5.31 is too low for a margined product, and 2% is not feasible as a stop loss amount (for CFD's). I don't quite understand your calcs as above.
Is it 2% of $5000 or 2% of the trade value? Your stop loss at $5.31 is 8%. Are you talking about risk ie the amount prepared to loose from your total trade acct or setting a stop value on the individual trade?. I'll show you a typical trade I do for example.

Buy 1000 CML @ $9.50 = $9500
At 5% margin I am required to deposit or contribute $475
Now if I'm only willing to loose 2% then my stop loss would be 475 X 2% = $9.75. For 1000 shares that equates to 1c, not practical. But if  you're total loss (from $5000) amount is $100, then your stop would be 1000/100 = 10c = $9.65. Does that make sense?  Even though the loss from the trade would be 100/475 > 20%.  Basically I set a dollar value as a stop or what I'm prepared to loose. How does everyone else do it?(trade CFD's).

Cobra

If you're trading CFD's, ie. Margined.... how do you calculate position size if you're trying to keep your stop loss to 2% of equity.

Eg: Let's say I want to buy LNN at 5.77 and my initial stop loss is at 5.31. If my trading bank is $5000 then my position size will be: $5000*2% = $100risk; $100/0.46 (5.77-5.31) = 217shares!

That's how I would normally enter the market buying the shares, but how do you approach it in a margined situation like CFD's, because if your stop is at 5.31, and it's hit, you'll lose more than your 2% of equity.

Thought I'd start a topic for CFD's for anyone wishing to chat about good or bad experiences with CFD's or providers.