Building in failure to help manage risk

[tomorton]

I understand the way you trade. Indeed one of my trading strategies is similar.

My point was simply the amount of contracts that you might eventually hold. The nominal amount could be v large in relation to your account. In other words the leverage could be huge. For (an extreme) example, a $10k account holding 10 contracts of crude oil has 64x leverage. Would you be ok with such leverage?

I trade through spreadbetting so my money calculations are simple. Contracts mean nothing to me I'm afraid and I've no idea what 64x leverage means for management of the trade.

When I open the first trade, say in oil, I set a stop-loss behind the entry price which will get me out for a set % loss from my account capital. Many people use 2% so let's say its 2%. On a £10k account that would mean a £200 loss. I'd be very comfortable with that. As I haven't ever used contracts I don't know how different your process would be from mine.

Are we maybe talking about different types of capital lost? I am only interested in account capital lost. So every trade on which I am stopped loses £200. But if I have 7 overlaid trades on oil, only the latest one's £200 loss is from account capital, the others' losses are from unrealised gains. On 7 trades that represents a potential total loss of £1400 obviously, but the gains from the earlier trades more than match this so I don't worry about that, the net result is considerably more profit than holding the original trade alone over the same price action.

 

[Visaria]

How about if there was a flash crash, the price goes through your stop loss (on your 7 trades) and the 1st price your SB firm gives you is 10% away, but because you have so much leverage, it means 70% loss?

 

[tomorton]

How about if there was a flash crash, the price goes through your stop loss (on your 7 trades) and the 1st price your SB firm gives you is 10% away, but because you have so much leverage, it means 70% loss?

This is something I have put up before but its a fair (and important) question.

Yes, such a severe crash through my stop on the 7 overlaid positions would be a serious loss but it would not be not 70%.

Assuming I started the 7 trades with a first trade at 5000, with a stop 100 lower at 4900, and a buy order on Trade 2 at 5100. The 7th trade would open at 5600 and stops on all the 7 trades would be at 5500. The price that would be 10% in capital terms below 5500 would be 5000 - i.e. 5 steps of 100 at 2% capital loss each. So the 7 trades close at 5000. At this price Trade 1 breaks even, T2 loses 2%, T3 loses 4%, T4 loses 6%, T5 loses 8%, T6 loses 10% and T7 loses 12%. Total losses are 42%.

A 42% loss is very bad but its not as bad as 70%. Nevertheless, in the event of a crash, all the eggs are admittedly in one basket.

But its a toss-up as to how to prepare for the next crash - take less risk or make more money to pay for the risk. Each to their own answer on this I guess, but as crashes are less common than trends, I know my choice.

Happy trading.