Risk Too Much and You Will Lose

October 21, 2008

I've been slowing getting my Forex "legs" back by reading a book I picked up months ago. The Book is called "Trade Your Way To Financial Freedom" by Van K. Thorp. I picked it up months ago based on recommendations from Simon over on his blog. I can see why he thinks so highly of this book because it is so different from the plethora of trading books out there. Van stresses managing reward to risk in your trades and position sizing. I was certainly most interested in his position sizing chapter of which I'll be talking about more in the future.

Poor position sizing can kill your account. Risk too much on any given trade and it could be impossible to recover. I've been down this road before and the reasons for this were inexperience and greed. If you were to open a $1000 trading account and you lose $200 on your first trade, this would be a 20% drawdown. The percentage gain you need to recover from this loss is a possibly manageable 25%. But if you were to lose $400 on your first trade, or a 40% drawdown, you would need a 66.7% gain to recover from this loss. This information may be trivial and known by many, but the extent isn't quite noticeable until you see the following table. Losses beyond 50% require "huge, improbable gains in order to get back to even."