What is the NLP
4 January 2023
Trading plan
4 January 2023
Now, let’s combine all the concepts you saw in the previous posts, in order to perfectly understand how you should organise your trading. Doing this will ensure that your aims are always clear in your mind, minimising the feelings and emotions that often lead to mistakes.
Asset allocation
A premise: if you trade with the intention of making a monthly income, then you need adequate capital. You cannot expect to earn 3,000 or 5,000 dollars a month with a trading account of 5,000 or 10,000 dollars.
Yes, it is true that some specific markets, such as Forex, allow you to operate with very high leverage. However, to get an income of that size, you also have to raise the risk levels quite a lot, and sooner or later, this will inevitably lead you to lose a good portion (if not all) of your initial capital. I am now going to proceed with a couple of examples, using a trading account of $ 50,000 with my examples.
First, you need to decide how to divide your capital into asset classes. In the table below, you can see an example of this, both in percentages and dollars.
Alongside deciding which part of your capital, you want to allocate to each asset, you can also choose, within each asset, the allocation by type of operation. For example, in Forex, you may decide to allocate 20% of your capital to day trading trades, and 80% to mid to long-term operations. If once you have done this, you decide to withdraw your earnings every month, this will not change anything. If, on the other hand, you were to decide to leave them in your account, you would have to re-balance your asset classes.
Part of capital for a single trade
Now that you have allocated your capital into asset classes, the next step is to decide the most you would be willing to invest in a trade for each asset. It is essential that you choose, before opening a trade, the part of the capital you are willing to use, And therefore risk, for that trade. It has to be an amount that will not create even the slightest problem, both for you and your trading account. If a trade requires a higher capital (margin) than you planned, you will not make that trade.
In the table below, an example of how much money you could allocate to each trade.
Percentage of maximum loss for each trade
Next, what you have to decide is the maximum loss you are willing to undergo in case the price hits the stop. A loss that would not cause any problems for you. Decide this for each asset class, as you can see in the example in the table below.
Important! The percentage must be calculated on the equity, so on the entire capital you have in your trading account, not on the part allocated to the asset classes.
Stop-loss and Position Size
At this point, you only have to decide where to place the stop-loss and, based on the maximum loss percentage, determine the position size to open. With options and spread trading, it is very easy to calculate how many contracts you can buy or sell.
With Equities, CFDs, ETFs, and Forex, it is slightly more complex. Would not cause any problems for you.
There are different ways to calculate position size, depending on the type of market. Below I will show you the formula you need for Stocks, CFDs, and ETFs, and then the one for Forex.
Stocks, CFDs, ETFs
Regardless of whether we operate with Stocks, CDFs or ETFs, the calculation is simple and always the same. Below you can see the formula:
Number of shares (LONG) = Max loss / (entry price – stop-loss)
Number of shares (SHORT) = Max loss / (stop-loss – entry price)
So, if for example, you open a long position on Twitter with an entry price of $ 43.00 and stop-loss at $ 38.00 and a maximum loss of $ 800, the number of shares to buy is:
Number of shares (LONG) = Max loss / (entry price – stop-loss)
So:
Number of shares = $ 800 / ($ 43.00 – $ 38.00) = 160
Based on your maximum loss and stop-loss, the number of shares you have to buy is 160. If the price reaches the stop-loss, you will lose exactly $ 800.
If instead, you established the maximum loss not with a fixed amount of dollars (or any other currency), but rather with a percentage, the formula would vary as follows:
Nr. of shares (LONG) = (capital x %of max loss) / (entry price – stop-loss)
Nr. of shares (SHORT) = (capital x %of max loss) / (stop-loss – entry price)
Where capital is the amount of money in your trading account and %of max loss is the maximum percentage of the money (in your account) that you are willing to lose in the trade.
If for example you have a trading account of $ 60,000 and you decide to open a short trade on Apple with an entry price at $ 230.00, a stop-loss at $ 240.00, and a maximum loss of 1.5% of the money in your account, the number of shares to sell would be:
Nr. of shares (SHORT) = (capital x %of max loss) / (stop-loss – entry price)
So:
Number of shares = ($ 60,000 * 1.5%) / ($ 240.00 – $ 230.00) = 90
Based on your percentage of maximum loss and stop-loss, the number of shares you have to sell is 90. In this way, if the price hits the stop-loss, your loss will be exactly the amount you established, that is, $ 900 (which corresponds to 1.5% of $ 60,000).
Now, let’s look at the formula for calculating the position size in Forex.
Forex
Now, I am going to show you how to open a proper Forex position based on your risk appetite. In this way, even if a currency pair reaches the stop-loss, this will not create any problems for your account, or cause you any additional stress.
Having completed your analysis, you decide to go short on Gbp-Jpy with an entry price at 133.000, a stop-loss of 134.500, and a target of 130.000. Your maximum bearable loss is $ 600. How much should you invest in this trade? You calculate what position size you should open with the formula:
Position Size = [(1,000 * max loss) / pips of stop] / value 1 pip
in this equation, max loss is your maximum bearable loss ($ 600); pips of stop is the distance in pips from the entry price to the stop-loss (150 in this example); the value of 1 pip is the minimum value of a pip for $ 1,000 of purchase/sale of Gbp-Jpy.
Returning to the example, the position size to open is as follows:
Position Size = [(1,000 * max loss) / pips of stop] / value 1 pip
So:
Position Size = [(1,000 * $ 600) / 150] / 0.09 = $ 44,444
Slightly rounded down, the position size to open is $ 44,400. I rounded down the result, but you can decide to round the amount as you prefer. Thus, this is a trade that would lose you $ 600 if the currency pair hit the stop-loss, just as we had planned.
Even here, if you establish the maximum loss not with a fixed amount in dollars (or in other currency) but with a percentage, the formula varies as follows:
Position Size = [(1,000 * (capital x %of max loss)) / pips of stop] / value 1 pip
Where, as you have already seen, capital is the amount of money in your trading account, and %of max loss is the maximum percentage of money in your account you are willing to lose if the trade were to go badly.
If for example you have an account of $ 50,000 and you decide to open a long position on Eur-Chf with an entry price at 1.0950, a stop-loss at 1.0780, and your maximum loss of 1% of your account, the position size you should open is:
Position Size = [(1,000 * (capital x %of max loss)) / pips of stop] / value 1 pip
So:
Position Size = [(1,000 * ($ 50,000 x 1%)) / 170] / 0.10 = $ 29,411
Rounded down, the position size to open is $ 29,400. This is a trade that would cause you to lose $ 500, or 1% of your account if Eur-Chf were to hit the stop-loss.
At this point, you must be wondering: how do I calculate the pip value of a currency pair? No problem, on the internet, there are several free tools, one of them is Myfxbook (https://www.myfxbook.com/en/forex-calculators/pip-calculator) that once entered all the parameters (USD, or other currency, Lots = 0.01 and Pips = 1), will automatically calculate the pip value for all the currency pairs.
Now, let’s combine all the concepts you saw in the previous posts, in order to perfectly understand how you should organise your trading. Doing this will ensure that your aims are always clear in your mind
I am a macroeconomic and financial analyst with over 30 years’ experience, including two years as a fund manager. I specialise in currencies and commodities, and I am the author of several successful books on trading, macroeconomics, and financial markets.
