Trading Essentials Framework Money Management & Trade Sizing 2.0

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2 Money Management: The most critical aspect of your trading plan Money management represents the administrative side of your trading plan. It addresses the question of how best to use the capital available to you in the most effective manner possible with the goal of MAXIMIZING your PROFITABILITY while at the same time PROTECTING your CAPITAL by MINIMIZING the RISK of ruin. The True Essence of Money Management Is Managing Risk: Wise money management is the basis of any good trading methodology and is what ultimately will help distinguish a consistently successful trader from the trader that consistently loses. Many traders have fallen to the wayside trying to make a lot of money on a single trade trying to hit that home run when they would have been better off making small (singles and doubles), steady gains. Once you start doing this (and thinking this way), you will see your account consistently starting to grow. Trading Concepts, Inc. 2

3 Money Management includes consideration of the following factors: Deciding on the OPTIMUM amount of money to commit to any one trade relative to your total available trading capital. PROTECTING your PROFITS from erosion. Avoiding (at all costs) turning a small losing trade into a huge losing trade. If you keep your losses small, your profits don t have to be home runs to earn a good living. Knowing when and how to increase the size of your cash commitment when the odds are more in your favor (i.e. risk to reward is really tilted in your favor, etc.). Recognizing the importance of taking some of your winnings off the table after a winning streak. Always Know Your Exit Before You Enter One of the cardinal rules of good trading is ALWAYS to have an EXIT point before you even enter a trade. If you know your initial risk, you can express all your results in terms of your initial risk. Trading Concepts, Inc. 3

4 Choosing a different E-Mini futures contracts to trade will have a different impact your risk management strategy: While a sound trading methodology will produce consistency in any market, a trader must consider the volatility of each market he/she is looking to trade so as to size his/her positions accordingly based on his/her individual risk tolerance and trading capital. The four most popular E-Mini futures are: the E-Mini S&P 500 futures contract, the E-Mini NASDAQ-100 futures contract, the E-Mini Dow, and the Russell 2000 Index Mini futures Trading is trading, whether one is trading the E-Mini S&P 500 or Light Sweet Crude Oil; it s all basically the same. However, there are some differences, such as margin, leverage, times of day the markets are open, limit locks, and volatility. While each market does have it s own personality, if you can trade one, you can trade the other. A determining factor in which market to trade is based primarily on your individual risk tolerance and trading capital. If the volatility of a market is a determining factor in position sizing accordingly, how does a trader define the volatility of a market? Trading Concepts, Inc. 4

5 RANGE Trading Essentials Framework What is Volatility? Most traders will define volatility in terms of market price action. If a market is inactive, it is considered non-volatile. If a market is very active, it is considered volatile. It is easy enough to look at a chart and point out a very volatile or a non-volatile market, but How can volatility be defined for each market? The one thing that is directly proportional to volatility is RANGE. RANGE is defined as the distance the price moves (minimum price fluctuation) per increment of time or simply the distance from the HIGH to the LOW of a price bar. HIGH LOW How can volatility be defined? Average True Range (ATR) Average True Range is an indicator, developed by J. Welles Wilder, that measures volatility. It is based on the high-low range of a price bar; however, it also captures volatility from a gap or limit up/down move. Trading Concepts, Inc. 5

6 What are the differences across the E-Mini futures contracts that a trader must know to position size accordingly? In defining the volatility of a market using the Average True Range (ATR), a trader also must know the profit/loss of each tick for each market he/she considers trading. E-Mini S&P 500 Futures (ES) Price Fluctuation: 0.25 index points = $12.50 profit/loss per tick size or $50 profit/loss per index point Daily average volatility (daily ATR x index points): index points = $1, (as of 11/30/2011) E-Mini NASDAQ-100 Futures (NQ) Price fluctuation: 0.25 index points = $5.00 profit/loss per tick size or $20 profit/loss per index point Daily average volatility (daily ATR x index points): index points = $ (as of 11/30/2011) E-Mini Dow Futures (YM) Price fluctuation: 1 index point = $5.00 profit/loss per tick size / index point Daily average volatility (daily ATR x index points): 221 index points = $1, (as of 11/30/2011) Russell 2000 Index Mini Futures Price fluctuation: 0.10 index points = $10.00 profit/loss per tick size or $100 profit/loss per index point Daily average volatility (daily ATR x index points): 20.1 index points = $2, (as of 11/30/2011) 6

7 Trade Sizing Most traders, as well as many top professional traders, do not realize the most important, nonpsychological component of trading/investing success, Trade Sizing! A Trade Sizing Strategy: Helps you determine how much equity to risk on every trade you take: Its purpose is to help you meet your objectives. You could have the world s best trading method (for example, one that makes money 95% of the time and in which the average winner is twice the size of the average loser), and you still could go bankrupt if you risked 100% on one of the losing trades. Helps you determine how much equity to risk given several inputs: Your trading strategy s risk, your personal risk tolerance, the kind of returns you want to make, and your own personal definition of ruin whether that s bankruptcy or some level of equity drawdown. Trading Concepts, Inc. 7

8 3 Components of Trade Sizing Trader s Psychology Trader s Objectives Position Sizing Method 8

9 3 Components of Trade Sizing 1) Traders Objectives: everyone has different objectives when he/she trades. You must determine what your personal objectives are. 2) Trader s Psychology: this influences the first component (the trader s objectives). What are your beliefs about your trading? What emotions come up when you re trading? What s your mental state? 3) Trade Sizing Method: for a lot of traders, this is intuitive. In other words, they really don t have an actual method or particular algorithm. You really need an exact method of trade sizing. A trader with NO objectives and NO trade sizing guidelines will trade size TOTALLY by emotions. Let me give you what I personally use Trading Concepts, Inc. 9

10 Trade Sizing Model A simple model for determining HOW MANY POSITIONS involves risking a percentage of your equity on every trade. You need to know three distinct variables: The CPR Model for Position Sizing 1. How much of your equity are you going to risk? This is your total risk, but we will call it cash (or C) for short. This will be the C in our CPR formula. For example, if you were going to risk 2% of your equity, C would be 2% of your equity. If you have a $25,000 account, C would be 2% of that, or $ How many units do you buy/sell (that is, what is your position sizing method)? We call this variable (P) for position sizing method. Which futures contract are you trading and how many contracts do you buy/sell? 3. How much are you going to risk per unit that you trade? We will call this variable (R), which stands for risk. For example, if you re going to buy the E-mini S&P 500 at and your risk is 3.00 Points or 12 Ticks ( ), then your risk R in this particular trade is $150. We will use this in our CPR Formula below. Use the following formula to determine how many contracts to trade: P = C / R (P) Position sizing = (C) total Cash at risk / (R) Risk (# of ticks * value of a tick) 10

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12 Trade Sizing Model Example (P = C / R) Let s say, for example, with a $100,000 account balance: You re willing to risk 2% of your account balance ($100,000 x.02 = $2000), or C = $2000. You BUY the E-Mini S&P 500 at with a risk of 3.00 ES index points, AND your broker charges a commission of $5.00 round turn per contract, or R = $155 (3.00 ES index points x $50 + $5.00). IF P = $2000 / $155, THEN you can trade up to 12 E-Mini S&P 500 futures contracts. You BUY the E-Mini NASDAQ-100 at with a risk of 5.00 NQ index points, AND your broker charges a commission of $5.00 round turn per contract, or R = $105 (5.00 NQ Index Points x $20 + $5.00). IF P = $2000 / $105, THEN you can trade up to 19 E-Mini NASDAQ-100 futures contracts. You BUY the E-Mini Dow at with a risk of 25 YM index points, AND your broker charges a commission of $5.00 round turn per contract, or R = $130 (25 YM Index Points x $5 + $5.00). IF P = $2000 / $130, THEN you can trade up to 15 E-Mini Dow futures contracts. You BUY the Russell 2000 Index Mini at with a risk of 1.7 TF index points, AND your broker charges a commission of $5.00 round turn per contract, or R = $175 (1.7 TF Index Points x $100 + $5.00). IF P = $2000 / $175, THEN you can trade up to 11 Russell 2000 Index Mini futures contracts. Trading Concepts, Inc. 12

13 Trade Sizing Model Example (P = C / R) Let s say, for example, with a $50,000 account balance: You re willing to risk 2% of your account balance ($50,000 x.02 = $1000), or C = $1000. You BUY the E-Mini S&P 500 at with a risk of 3.00 ES index points, AND your broker charges a commission of $5.00 round turn per contract, or R = $155 (3.00 ES index points x $50 + $5.00). IF P = $1000 / $155, THEN you can trade up to 6 E-Mini S&P 500 futures contracts. You BUY the E-Mini NASDAQ-100 at with a risk of 5.00 NQ index points AND your broker charges a commission of $5.00 round turn per contract, or R = $105 (5.00 NQ index points x $20 + $5.00). IF P = $1000 / $105, THEN you can trade up to 9 E-Mini NASDAQ-100 futures contracts. You BUY the E-Mini Dow at with a risk of 25 YM index points, AND your broker charges a commission of $5.00 round turn per contract, or R = $130 (25 YM index points x $5 + $5.00). IF P = $1000 / $130, THEN you can trade up to 7 E-Mini Dow futures contracts. You BUY the Russell 2000 Index Mini at with a risk of 1.7 TF index points, AND your broker charges a commission of $5.00 round turn per contract, or R = $175 (1.7 TF index points x $100 + $5.00). IF P = $1000 / $175, THEN you can trade up to 5 Russell 2000 Index Mini futures contracts. Trading Concepts, Inc. 13

14 Trade Sizing Model Example (P = C / R) Let s say, for example, with a $25,000 account balance: You re willing to risk 2% of your account balance ($25,000 x.02 = $500), or C = $500. You BUY the E-Mini S&P 500 at with a risk of 3.00 ES index points, AND your broker charges a commission of $5.00 round turn per contract, or R = $155 (3.00 ES index points x $50 + $5.00). IF P = $500 / $155, THEN you can trade up to 3 E-Mini S&P 500 futures contracts. You BUY the E-Mini NASDAQ-100 at with a risk of 5.00 NQ index points, AND your broker charges a commission of $5.00 round turn per contract, or R = $105 (5.00 NQ index points x $20 + $5.00). IF P = $500 / $105, THEN you can trade up to 4 E-Mini NASDAQ-100 futures contracts. You BUY the E-Mini Dow at with a risk of 25 YM index points, AND your broker charges a commission of $5.00 round turn per contract, or R = $130 (25 YM index points x $5 + $5.00). IF P = $500 / $130, THEN you can trade up to 3 E-Mini Dow futures contracts. You BUY the Russell 2000 Index Mini at with a risk of 1.7 TF index points, AND your broker charges a commission of $5.00 round turn per contract, or R = $175 (1.7 TF Index Points x $100 + $5.00). IF P = $500 / $175, THEN you can trade up to 2 Russell 2000 Index Mini futures contracts. Trading Concepts, Inc. 14

15 Trade Sizing Model Example (P = C / R) Let s say, for example, with a $12,500 account balance: You re willing to risk 2% of your account balance ($12,500 x.02 = $250), or C = $250. You BUY the E-Mini S&P 500 at with a risk of 3.00 ES index points, AND your broker charges a commission of $5.00 round turn per contract, or R = $155 (3.00 ES index points x $50 + $5.00). IF P = $250 / $155, THEN you can trade up to 1 E-Mini S&P 500 futures contracts. You BUY the E-Mini NASDAQ-100 at with a risk of 5.00 NQ index points, AND your broker charges a commission of $5.00 round turn per contract, or R = $105 (5.00 NQ index points x $20 + $5.00). IF P = $250 / $105, THEN you can trade up to 2 E-Mini NASDAQ-100 futures contracts. You BUY the E-Mini Dow at with a risk of 25 YM index points, AND your broker charges a commission of $5.00 round turn per contract, or R = $130 (25 YM index points x $5 + $5.00). IF P = $250 / $130, THEN you can trade up to 1 E-Mini Dow futures contracts. You BUY the Russell 2000 Index Mini at with a risk of 1.7 TF index points, AND your broker charges a commission of $5.00 round turn per contract, or R = $175 (1.7 TF index points x $100 + $5.00). IF P = $250 / $175, THEN you can trade up to 1 Russell 2000 Index Mini futures contracts. Trading Concepts, Inc. 15

16 $10,000 Account (Risk = 2.50 ES points) 2% of $10,000 = $200 max loss: IF $125 Risk x 1 = $125 + $5* = $130 AND P = $200 / $130 (per contract), THEN trade ONLY 1 ES contract! $25,000 Account (Risk = 2.50 ES points) 2% of $25,000 = $500 max loss: IF $125 Risk x 1 = $125 + $5* = $130 AND P = $500 / $130 (per contract), THEN trade up to 3 ES contracts! $50,000 Account (Risk = 2.50 ES points) 2% of $50,000 = $1000 max loss: IF $125 Risk x 1 = $125 + $5* = $130 AND P = $1000 / $130 (per contract), THEN trade up to 7 ES contracts! E-Mini S&P 500 (ES) 1.00 Point = $50 or 1 Tick = $12.50 Profit/Loss $7,500 Account (Risk = 2.25 ES points) 2% of $7,500 = $150 max loss: IF $ Risk x 1 = $ $5* = $ AND P = $150 / $ (per contract), THEN trade ONLY 1 ES contract! $15,000 Account (Risk = 2.25 ES points) 2% of $15,000 = $300 max loss: IF $ Risk x 1 = $ $5* = $ AND P = $300 / $ (per contract), THEN trade up to 2 ES contracts! *Calculations based on $5.00 round turn per contract broker commission $30,000 Account (Risk = 2.25 ES points) 2% of $30,000 = $600 max loss: IF $ Risk x 1 = $ $5* = $ AND P = $600 / $ (per contract), THEN trade up to 5 ES contracts! 16

17 $15,000 Account (Risk = 22 NQ ticks) 2% of $15,000 = $300 max loss: IF $110 Risk x 1 = $110 + $5* = $115 AND P = $300 / $115 (per contract), THEN trade up to 2 NQ contracts! $30,000 Account (Risk = 22 NQ ticks) 2% of $30,000 = $600 max loss: IF $110 Risk x 1 = $110 + $5* = $115 AND P = $600 / $115 (per contract), THEN trade up to 5 NQ contracts! $75,000 Account (Risk = 22 NQ ticks) 2% of $75,000 = $1500 max loss: IF $110 Risk x 1 = $110 + $5* = $115 AND P = $1500 / $115 (per contract), THEN trade up to 13 NQ contracts! E-Mini NASDAQ-100 (NQ) 1.00 Point = $20 or 1 Tick = $5 Profit/Loss $5,000 Account (Risk = 13 NQ ticks) 2% of $5,000 = $100 max loss: IF $65 Risk x 1 = $65 + $5* = $70 AND P = $100 / $70 (per contract), THEN trade ONLY 1 NQ contract! *Calculations based on $5.00 round turn per contract $10,000 Account (Risk = 13 NQ ticks) 2% of $10,000 = $200 max loss: IF $65 Risk x 1 = $65 + $5* = $70 AND P = $200 / $70 (per contract), THEN trade up to 2 NQ contracts! $25,000 Account (Risk = 13 NQ ticks) 2% of $25,000 = $500 max loss: IF $65 Risk x 1 = $65 + $5* = $70 AND P = $500 / $70 (per contract), THEN trade up to 7 NQ contracts! 17

18 $15,000 Account (Risk = 19 YM points) 2% of $15,000 = $300 max loss: IF $95 Risk x 1 = $95 + $5* = $100 AND P = $300 / $100 (per contract), THEN trade up to 3 YM contracts! $30,000 Account (Risk = 19 YM points) 2% of $30,000 = $600 max loss: IF $95 Risk x 1 = $95 + $5* = $100 AND P = $600 / $100 (per contract), THEN trade up to 6 YM contracts! $75,000 Account (Risk = 19 YM points) 2% of $75,000 = $1500 max loss: IF $95 Risk x 1 = $95 + $5* = $100 AND P = $1500 / $100 (per contract), THEN trade up to 15 YM contracts! E-Mini Dow (YM) 1 Point/Tick = $5 Profit/Loss $5,000 Account (Risk = 13 YM Points) 2% of $5,000 = $100 max loss: IF $65 Risk x 1 = $65 + $5* = $70 AND P = $100 / $70 (per contract), THEN trade ONLY 1 YM contract! *Calculations based on $5.00 round turn per contract $10,000 Account (Risk = 13 YM Points) 2% of $10,000 = $200 max loss: IF $65 Risk x 1 = $65 + $5* = $70 AND P = $200 / $70 (per contract), THEN trade up to 2 YM contracts! $25,000 Account (Risk = 13 YM Points) 2% of $25,000 = $500 max loss: IF $65 Risk x 1 = $65 + $5* = $70 AND P = $500 / $70 (per contract), THEN trade up to 7 YM contracts! 18

19 $15,000 Account (Risk = 2.7 TF points) 2% of $15,000 = $300 max loss: IF $270 Risk x 1 = $270 + $5* = $275 AND P = $300 / $275 (per contract), THEN trade ONLY 1 TF contract! $30,000 Account (Risk = 2.7 TF points) 2% of $30,000 = $600 max loss: IF $270 Risk x 1 = $270 + $5* = $275 AND P = $600 / $275 (per contract), THEN trade up to 2 TF contracts! $75,000 Account (Risk = 2.7 TF points) 2% of $75,000 = $1500 max loss: IF $270 Risk x 1 = $270 + $5* = $275 AND P = $1500 / $275 (per contract), THEN trade up to 5 TF contracts! Russell 2000 Mini Index (TF) 1.0 Point = $100 or 1 Tick = $10 Profit/Loss $10,000 Account (Risk = 2.3 TF points) 2% of $10,000 = $200 max loss: IF $230 Risk x 1 = $230 + $5* = $235 AND P = $200 / $235 (per contract), THEN NO TRADE! $25,000 Account (Risk = 2.3 TF points) 2% of $25,000 = $500 max loss: IF $230 Risk x 1 = $230 + $5* = $235 AND P = $500 / $235 (per contract), THEN trade up to 2 TF contracts! *Calculations based on $5.00 round turn per contract broker commission $50,000 Account (Risk = 2.3 TF points) 2% of $50,000 = $1000 max loss: IF $230 Risk x 1 = $230 + $5* = $235 AND P = $1000 / $235 (per contract), THEN trade up to 4 TF contracts! 19

20 Multiple Open Positions - Trade Sizing Model Let s say, for example, with a $50,000 account balance: You re willing to risk 2% of your $50,000 account balance on any one trade, and you have ONE open position. You are looking to put on another position, and you have to assume the first open position may be a losing trade; therefore, you need to base your trade size of the second position on an account balance of $49,000. First trade ($50,000 x.02 = $1000) or C = $1000 Second trade ($49,000 x.02 = $980) or C = $980 Third trade ($48,020 x.02 = $960) or C = $960 First position (based on account balance of $50,000) You BUY the E-Mini S&P 500 at with a risk of 3.00 ES index points, AND your broker charges a commission of $5.00 round turn per contract, or R = $155 (3.00 ES index points x $50 + $5.00). IF P = $1000 / $155, THEN you can trade up to 6 E-Mini S&P 500 futures contracts. Second position (based on account balance of $49,000) You BUY the E-Mini NASDAQ-100 at with a risk of 5.00 NQ index points, AND your broker charges a commission of $5.00 round turn per contract, or R = $105 (5.00 NQ index points x $20 + $5.00). IF P = $980 / $105, THEN you can trade up to 9 E-Mini NASDAQ-100 futures contracts. Third position (based on account balance of $48,020) Trading Essentials Framework You BUY the E-Mini Dow at with a risk of 25 YM index points, AND your broker charges a commission of $5.00 round turn per contract, or R = $130 (25 YM index points x $5 + $5.00). IF P = $960 / $130, THEN you can trade up to 7 E-Mini Dow futures contracts. 20

21 Money Management / Trading Sizing Tips Have a written trading plan ; this will help you stay focused on your goal of trading success. In addition, it will help you learn from your mistakes and successes, which thereby will help you improve your trading abilities as time goes by. You should look only to take trades where there is relatively low risk compared to the reward potential for the trade. Always use well placed stop-loss orders; this is the only way to limit any damage to your account and helps ensure your overall trading success. You need to be willing to short the market as much as you re willing to buy the market. Never risk more than 2% of your entire account on any one single trade. When you have a profitable month, pay yourself by withdrawing some money from your account and put it in the bank. Until you know your trading methodology really well, I recommend that you risk a maximum of 1% of your entire account equity on any one position. Trading Concepts, Inc. 21

22 A Quick Word on Trader Psychology One huge reason why successful trading can be so difficult to achieve is the emotions that are wrapped up in the money we trade. If in our minds we are equating the money on the next trade with the money needed for the car payment, the kids tuition money, or the mortgage, we may be on a sure path to trading failure. If it is money we can t afford to lose, it is money we simply can t afford to trade. If we attach emotions to the money at risk, we are much more likely to commit trading errors, which is as bad as having a bad trading methodology to follow. Trading Insight Something that has had a profound effect on my investing comes from Norman Vincent Peale, author of The Power of Positive Thinking: "People become really quite remarkable when they start thinking that they can do things. When they believe in themselves; they have the first secret of success." When you feel that you actually can take control of your trading and investment destiny, the empowerment of that control will take you to the success you are seeking. If you think you can...or if you think you can't...you're right. - Henry Ford Trading Concepts, Inc. 22

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24 No claim is made by the Trading Concepts, Inc. that the futures trading strategies shown here will result in profits and will not result in losses. Futures trading may not be suitable for all recipients of this Training Program. All comments, trading strategies, techniques, concepts and methods shown within our Course are not and should not be construed as an offer to buy or sell futures contracts they are opinions based on market observation and years of experience. Therefore, the thoughts expressed are not guaranteed to produce profits in any way. All opinions are subject to change without notice. Each futures trader/investor is responsible for his/her own actions, if any. Your purchase of the Trading Concepts Comprehensive EMINI SUCCESS FORMULA 2.0 Mentoring Program constitutes your agreement to this disclaimer and exempts Trading Concepts from any liability or litigation. Trading Concepts, Inc. 24

25 All rights reserved. This Training Program, or parts thereof, may not be reproduced in any form without the prior written permission of Trading Concepts, Inc. Trading Concepts, Inc. 25