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Risk management is an essential skill any trader needs. Taking safety measures when investing is the only way to ensure your career doesn’t end with the first failed position.
The fixed fractional money management strategy is one of the best ways to measure trade size. It’s important to know how much of your capital you’re risking per trade.
1. What is the fixed fractional system?
Ralph Vince was the creator and designer of the fractional money management system. He says that the number of units traded is based on operational risk. It means that the risk of a trade is a part of the net worth. The amount of capital or money that a person risks losing for each transaction is the operating risk.
We can say that the risk is no more than the same percentage of the capital that is available for trading. It allows us to see that the same amount of risky money increases or decreases proportionally to the equity after a transaction is successful or failed.
2. How you can use this approach?
This system has several advantages that allow us to increase our investment security. One of these is that as long as the trader has successful operations and his capital is increased proportionally, he will also gradually increase his position to what we call a compound effect.
You will gradually increase your profits if this trading strategy is successful. It also has an inverse effect means that if he goes on a losing streak, automatically, his capital and position will be reduced. For each loss or profit, it will affect the balance of your account.
3. What's the formula for this method?
This system can be demonstrated effortlessly and practically of utilizing a formula.
f x (equity/trading risk|) = N
Where:
F: it is the fixed fraction of your account that you are willing to risk with a trade.
Financial risk means the amount of money you could lose each position. It is put into an absolute value due to how a negative value represents a loss, and the calculation to work, it has to be positive.
Equity: it’s the value of your commercial capital.
N: it’s the number of trades or positions you can hold given your capital size.
4. Something to keep in mind
This system also has some disadvantages that we will name next:
In the first place, your position resizes with each trade. This means that recovering from losing streaks is difficult with a smaller trading size, but winning streaks also increase your investment, and this can reach uncomfortable levels.
Another big problem is for people who have small accounts. Because they will find it difficult to adjust to the size of their position, due to the standardized lot sizes which sometimes can be quite large. Also, if you want to increase the size of your position, you have to have a very high yield to improve the balance of your account. If you rush and don't wait for your account balance to increase enough to increase your position, you could be risking too much.
