Risk vs Return

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Trading Manual: Step-by-Step …

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Accurate assumptions about the future risk and performance? We need Standardisation and Statistics:

Standardisation by using a fixed autotrading strategy && history and statistics to make assumptions about the Future Performance/Risk. A Risk & Return Analysis to calculate a responsible way to invest giving us a clear picture of expected Return and the Risk we’re facing.

What keeps a ship afloat? The reason a ship stays afloat is because there is a buoyant force acting upon the ship. This buoyant force is equal to the ships weight, basically canceling out the ship, keeping it afloat. Trading spot currencies involves substantial risk and there is always the potential for loss. To trade responsible, (to keep the right balance) there are some rules to bear in mind when trading currencies concerning risk vs. equity account. (moneymanagement)

Most important rule: drawdown of system = max 20% equity trading account.

To apply this rule, we have to know the Max. drawdown of the Signal Providers Strategy. Therefore we need LIVE data of the strategy.

Please use a bank and trading account. After each month of trading, both accounts need to be equal again. For example, when investing $10.000,– with PipShip. From the start there is a trading account of $5000,– and bank account of repeatedly $5000,–.

This is an extra method of minimizing the risk when trading. Still a broker can go bankrupt. Or there can be a huge gap in the market exceeding the stop loss levels of the strategy. By using a bank account of 50% equity, we manage to have an extra margin of safety.

Account: Max risk: Max risk after scaling up the amount of lots:
Trading acc. Max. 6% equity down Max. 20% profit down

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Max DD (drawdown) strategy = -600 pips.

(1 pip is the term traders use for 1/100 cent profit or loss in the forex market.
Difference of EURUSD 1.35 towards 1.34 exchange rate is 100 pips)

  • 600 pips (max DD) = 6% equity. (Max Risk is 6%)
  • Account = $1000,–
  • Lots ratio is : number mini lots / each $1000.

(Lots or miniLots (mLots): the amount of money we put on the table…)
(mini Lots/$1000: the amount of money we put on the table…
…each $1000 we do have in our trading account)

100 pips difference && 0.1 mini lots = $10,–
600 pips = $60,–/each $1000,–. (6%)
We therefore need -> 0.1 mini lots each $1000,–.

-> We will use 0.1 mini lots each $1000,–.

 

Risk & Risk and Return in dollars:

  • 600 pips = $60,–/each $1000,–. (see above)

 

Then a drawdown of 600 pips && account = $1000,– ->

Drop of max 6% = max loss $60,–.

Return = 600 pips each month -> Profit = $60,– each $1000,–.
This is not the profit we would like to earn, but there is a way to increase our profit…

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We are able to scale up lotsize ratio using the following procedure:

Month Lots Risk-meter If account is up: %/month:
Month 1 0.1 mLots/$1000 Risk-meter 7% START 7%
Month 2 0.2 mLots/$1000 Risk-meter 13% If acc is +600 pips 13%
Then… 0.3 mLots/$1000 Risk-meter 20% If acc is +1200 pips 20%

Then first months the risk was max 6% of original equity in the trading account. After trading first 2 months we will earn 20% — each month — (and continue to grow exponentially). Because we will use a bank account of 50% equity, in total we grow with 10% each month.

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Return 4 years trading with PipShip and start capital is E10.000,– (-6% risk original deposit) (hypothetical) and two times blow up account PipShip (drawdown exceeds the -600 pips level = kick in Capital Protection = all (active) trades are cancelled)

Absolute Stop (zuluguard) = 600 pips. Equity Trading acc. : E 5.000,–. Equity Bank acc. : E 5.000,–.

Period Event Percentage Perc. total Equity both acc.
1st year
month 1
Halleluja! Crash PipShip!
(loss = -6% is E 300,–)
loss = -6% -3% E 9.700,–
1st year
month 2
hit Absolute Stop? -> start over again trading lowest lotsize… +7% +3% E 10.000,–
1st year
month 3
total +600 pips? -> increase lotssize… +13% +6% E 10.600,–
1st year
month 4 –
month 12
total +1200 pips? -> increase lotssize… 1,2 ^ 9 = 5,16 1,1 ^ 9 = 2,36 E 25.000,–
2nd year
trading
trading 12 months and no crash…
OW YEAH!
1,2 ^ 12 = 8,92 1,1 ^ 12 = 3,14 E 78.500,–
3rd year
trading
OW MY GOD!! CRASH AGAIN!!! hallelujah!!! loss = -20% -10% E 70.000,–
3rd year
month 2
hit Absolute Stop? -> start over again trading lowest lotsize… +7% +3% E 72.000,–
3rd year
month 3
total +600 pips? -> increase lotssize… +13% +6% E 76.000,–
3rd year
month 4 –
month 12
total +1200 pips? -> increase lotssize… 1,2 ^ 9 = 5,16 x 1,1 ^ 9 = 2,36 E 180.000,–
4th year no crash… 1,2 ^ 12 = 8,92 1,1 ^ 12 = 3,14 E 560.000,–

There is no need for taking too much risk / not scaling up the lotssize ratio / not using an absolute stop!

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How to fill in the parameters? -> Trading Manual: Step-by-Step …

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Absolute Stop or Capital Protection:

We are able to set an equity level in our trading account to limit the amount of loss/risk. When hitting this equity level (by drawdown of the system) all positions you are holding in the market will be closed. No new positions will be opened. The system will be freezed a couple of days so clients are able to consider whether or not to follow pipship again.

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Stop increasing the lotssize after reaching 0.3 minilots / $1000. Because…

When trading with 0.3 minilots / $1000, your trading account can drop with max 20%. (trading with the final lotsamount and normal risk approach) This is a huge drop! But we already gained this percentage, so max total risk of original deposit is still max 6% risk.

When using percentages the following phenomenon needs some attention:
If loss is:

-10% -> you need 11% to make up the loss.
-20% -> you need 25% to make up the loss.
-30% -> you need 43% to make up the loss.
-40% -> you need 67% to make up the loss.
-50% -> you need to double your account to get back to your original deposit!

This is why losing big really hurts. Make sure this does not happen! -> use the moneymanagement rules discribed on this page! (and stick to it!)

Notice the increase in percentage you need to make up a loss. This is why we do not advise you to use a risk amount above 20% current deposit. (and 0.3 minilots / $1000 is max lotssize ratio!) Below -20%, the percentage to make up the loss really starts to have it’s negative influence on your trading. (it limits the possiblity to increase the lotssize over and over again by gaining in the previous months)

The sample above illustrates the reason why you have to stop increasing the lotsamount after reaching 0.3 minilots / $1000!

Hit Stop? (netto = profit?) Start again… (6% max risk, scaling up the lots ratio).

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Probability of not gaining profit with PipShip; the risk vs return ratio…

It’s important not to hit the Abs Stop the first 2 months. (because then you will hit the -6% risk level of original deposit) After trading the first 2 months we gained enough profit to take the loss of hitting the absolute stop, then scaling up the lotssize again. According to the LIVE performance of PipShip, we think we will hit the absolute stop once every two years. (We also made the prospect above with an average time of 2 years till hitting the stop).

For example: When trading one year there is a probability to hit the stop of 50%.
Then by trading the first 2 months we face a probability to hit the stop of about 8%. (risking the first time 6% of our deposit) Then we only look at the technical probability of success of the system itself. Of course a bad trading philosophy/greediness of the investor -> overtrading -> not succeeding, this probability is not included.

The probability to hit the Abs Stop (-600 pips) could also be lower. (1 hit in 3 years instead of 1 hit in 2 years) It’s a speculative subject. Only by gathering more LIVE performance data, more accurate statements can be made. But still then, we cannot look into the future. There is always a probability of not making any profits with PipShip. (the risk of trading with PipShip) There is only an oppertunistic probability on gaining profit the first time risking 6%. (about 92%)

Hit Stoploss during the first 2 month period? Bad luck? Exceptional Market Circumstances? Or a bad Signal Provider Strategy?

Trying a second time after losing 6%, (probability of 12% of hitting the Abs Stop) the technical probability of not succeeding is still 12%. (again same characteristics) But in total, the probability of gaining profit with PipShip is far higher. (1-0.08^2 x 100% = 99%) About a probability of 99% of gaining profit with PipShip risking 12% of the trading accounts equity (6% of the original investment).