Arguably, the most important part of a successful trading plan is sound risk management. I've recently had to take another look at this as I am only human and fell back into some bad habits. After a fantastic 2nd quarter and some decent gains, I feel I may have become overconfident and adjusted my position sizing too high.
I pretty much broke even over the summer, but then took some large hits over Sept/Oct. I have to admit, my rules for sizing in different market conditions were not very clear even to me and needed more definition. Because of their loosely defined status, I had trouble really trusting my system and didn't have a plan for what to do when I had conflicting signals and which ones to prioritize. This was a major mistake. Thankfully, I know at this point to cut losers even when it hurts and overall I'm not really damaged just a bit disappointed. There's no room for impatience in trading.
In the end, this is a probabilities game and our rules determine our outcomes. Without those probabilities, it is difficult to project trade expectancy and profitability. It was high time I nailed these data points down and I have found it to be a very rewarding exercise. Thus, I am sharing a spreadsheet I made up that simulates trade outcome with five known factors: initial account balance, percentage of trades that gain, the percentage of balance designated for risk taking, the average percentage gained on a profitable trade, and the average percentage lost on a losing trade.
All adjustable factors are highlighted yellow. Change any others and the calculation won't work right anymore. The sheet contains a random number generator and will regenerate on any cell change. To refresh the numbers quickly, place the cursor on the dividing line between column headers as if you were going to adjust the column width. Then just click and release and all the numbers will regenerate. To get a better idea of how useful (or useless as the case may be) a risk management plan may be, generate numbers at least 30 times and take the result at a single point, say the 25th trade (you'll see those results in the sheet). If you place each result in column L rows 5 to 34, L35 will average those results automatically.
Have fun playing with the sheet and see that the most important factor is controlling your drawdown. After that, your gains don't need to be extremely big or even extremely often and you'll still be profitable in the end.
Good trading to all.
Download Probability Simulator
