Hi all, Market Wizard Larry Hite once recommended risking no more than 1% of a trading account on any one trade. But a compound calculator doesn't follow this rule. It assumes I reinvest all my profits on the next trade. Is my risk of ruin really that much higher if I don't follow the 1% rule? Is it suicidal to set my account risk to, say, 100% if my trade risk is 3%? Thanks
A standard compound calculator doesn't assume you re-invest all your profit, obviously the size will increase gradually as the account increases, but it's still a fixed x%. Unless you are using some other formula.
In pure theory it is harder to come back from a losing streak. You lost 20% means you must make 25% to be at 100% again. This influences your risk reward ratio. The bigger the percentage the more you have to come back. Also at some point (f.e. 30% of capital lost) you stop your system and the more risk you take, the smaller your losing streak has to be to reach it
Risking 1% doesn't mean that you can't put more than 1% in a given trade. It means that you limit you maximum loss per trade (position) to 1%. That's what risk management is.
Depends on the the win rate and expectancy, as well as the trade frequency. I am going to assume exponential bet sizing below: If you're concluding 1 trade/day or more on a reasonably profitable strategy there's absolutely no need to risk more than 1% of your account to grow the account. If you're making some really slow trades over several months, a few over the year, then 1%/trade will not be growing your account at a very impressive rate. But then the question is what your return profile is: for instance a profitable strategy with 10% win rate (outsized wins) is going to do much better with smaller bets simply because a losing streak is going to wipe the account (practically, making it too small to allow wins to work for you). On the other hand, a very selective strategy with high win rate and high profitability (not very outsized losses) you can bet far far more if you're willing to deal with the DDs. What I described was the common sense version. Notice how it depended on the win rate and profit factor. There is a mathematical treatment that you can use: The Kelly criterion: https://en.wikipedia.org/wiki/Kelly_criterion The Kelly criterion defines a maximum size of the bet that can helpful, any larger probably is going to lose you money you could have made. This bet size is usually far too large, given the fact you don't know the true parameters of future outcomes. But it helps you narrow down what to look for. An alternative to using Kelly criterion is to simply backtest your past trades and see what would have happened with various bet sizes. Or you can even do something super simple like simulating random outcomes based on your parameters and observe what happens to your simulated equity for various bet sizes. The advantage of such testing is that it lets you reason about this on your own rather than ask people and you're then more likely to understand why.
You are mixing up two different concepts. You can invest your entire balance but still risk only 1% of such balance on individual trades. Depends on the riskiness of the asset you are trading. On some low risk assets you may even be allocating twice the entire account balance (leverage) and still only risk less than 1% on a single position.
Of course but that is the fallacy of the markets, the reality is your risk is correlated to your return, 1% risk to account means 1% profit target, the real question is the timeline. Most will work on a day trading basis with this number targeting monthly, which is towards 15-20% pa, some can target it weekly, some even daily, a few can half this so you target 50% pa with 25% pa risk, but that requires some quite spectacular fintech to do all the work for you. But, the compounding also works on that targeting timeline, if you increase your profit by 1% per month then you would increase the unit size after that one month, the markets have calculated every combination of everything, sure you can do it differently but it will not end well.