My general heuristic is to plan for 12 losses in a row. This will be very rare but can happen. You have to factor in the probability of the loss and the size of the loss to really know the answer to this. They are not the same thing!!!
Using my simple heuristic, take 20% and dividing by 12 gives approximately 1.7%.
Based on this you would assume you could risk 1.7% max on this trade. However, let's say you set a stop of size X and that stop has a 1% chance of historically being hit. You will see that this estimate may be quite conservative.
You could be more aggressive then by taking some small but higher probability of a risk of ruin and bet more aggressively. I.e, perhaps 80% of your losers have a 20 point stop, you could set your 1.7% at the 20% probability. These are all just rough estimates, you understand. Another even more aggressive posture would be to make the 1.7% the loss of your average loss which would make your max risk higher.
A 20% max drawdown tolerance isn't a very aggressive risk tolerance, I might add.
I think what most people don't understand is that there is a probability (unknown) of various losses and gains. It will benefit you to start to think in terms of probabilities instead of definites. okay I'm willing to take 20% drawdown at the X% confidence level.
In reality, most trading methods that work have a small probability of a quite large loss. This is because the uncertainty factor of the rare event is rather high. And, this is something that most beginners (not saying you are) do not really comprehend.
Using my simple heuristic, take 20% and dividing by 12 gives approximately 1.7%.
Based on this you would assume you could risk 1.7% max on this trade. However, let's say you set a stop of size X and that stop has a 1% chance of historically being hit. You will see that this estimate may be quite conservative.
You could be more aggressive then by taking some small but higher probability of a risk of ruin and bet more aggressively. I.e, perhaps 80% of your losers have a 20 point stop, you could set your 1.7% at the 20% probability. These are all just rough estimates, you understand. Another even more aggressive posture would be to make the 1.7% the loss of your average loss which would make your max risk higher.
A 20% max drawdown tolerance isn't a very aggressive risk tolerance, I might add.
I think what most people don't understand is that there is a probability (unknown) of various losses and gains. It will benefit you to start to think in terms of probabilities instead of definites. okay I'm willing to take 20% drawdown at the X% confidence level.
In reality, most trading methods that work have a small probability of a quite large loss. This is because the uncertainty factor of the rare event is rather high. And, this is something that most beginners (not saying you are) do not really comprehend.
