Money management

Fixed-fraction money management

Written by Tim T.


Among the most widespread and most commonly recommended methods of capital management tools, which are traded on margin, we can mention the method of fixed - fractional trading, which in the course of its evolution had many different incarnations. In common, the money management methods which are based on the principles of fixed factionalism lie in the fact that in every deal you put at risk certain % of your account. Here are some of those ways.

One contract for every "x" dollars of your account.

This is one of the most popular advice of professionals: for example, for every $ 10,000 of your account you buy a contract. If a trader has a $ 100,000 account he can trade 10 contracts. If the maximum loss per deal is $ 1,000 then the risk will be 10000 or 10% of the deposit. However, if he gets three losing trades in a row the trader can lose up to 30% of account balance.

Optimal fraction.

f = number of contracts * greatest losses in one contract / size of the deposit.

This formula became popular due to Ralph Vince. Optimal f is defined as a fixed fraction, which gives more revenue than any other fixed fraction which can be used in this scenario. However, the optimal percentage rate which was chosen for one transaction will not necessarily be optimal for another one. The method can lead to phenomenal growth of the account as well as to significant losses.

Safe faction.

In contrast to the optimal fraction, this method doesn't offer to take into account the maximum potential loss per transaction but the drawdown of the account. The method of safe fraction is less risky than the method of optimal fraction but your deposit will grow more slowly, especially if you have a small deposit.

Risk of 2-3% per deal.

This is a variant of a fixed-fractional method, which is often used by managers of funds. However, this method is also often recommended for individual traders.
The main problem of this method is not the volume of risk. The crucial factor is growth. So if the potential loss per contract is $ 1000, then

$ 1,000 / 0.02 = $ 50,000

In other words, for every $ 50,000 of your account you can buy one contract. According to this strategy, if you have deposit of $ 100,000, you can not proceed to three contracts, while the amount of you account doesn't reach 150,000. For traders with a deposit of 50 000 such scenario is impossible as it is the minimum balance for your work with this strategy. However, this method can be used by fund managers. For example, if a fund owns $ 20 million, the potential loss per contract is $ 2000, the transaction will include 100 contracts (20000000 / 2000 = 100), the potential loss is $ 200,000 or 1%. If the deal is profitable the account will grow to 20200000 and the second transaction is already possible with 101 contract. In contrast to some traders who may spend years on expanding the volume of contracts, the managers of large funds can sometimes use the growth from a single transaction.


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