Our first line of defense against excessive losses is to trade with low leverage (i.e. a total of 7:1 for all trades combined).
The second line of defense is to spread our trade entries across the Grid (and not to go “all in” at a single entry price).
Our third line of defense is now to make trade entries of appropriate lot sizes within the Grid.
All lines of defense work in synergy with each other. Leaving any one out can disable entire defense system, so pay close attention to how each component works.[divider_padding]
Percentage of Maximum Lot Size[divider]
To best explain this concept, let’s assume a trading account of $5,000 capital. With a maximum leverage of 7:1, we can trade a total of ($5,000 x 7) $35,000 worth of currency – this is the equivalent of 3.5 mini lots. In other words, the total lot size of all our trades combined must not exceed 3.5 mini lots.
We must now decide how much of the total 3.5 mini lots we’ll be trading with, depending on where the market price is within the Grid.
This diagram shows the maximum percentage of the total trading lot size to use, based on which section (S1 – S4) of the Grid our entries are taken.
In S1, we should only be taking SHORT trades, with a maximum of 40% of the total lot size.
In S2, we can go SHORT with a maximum of 30% of the total lot size, or go LONG with a maximum of 20% of the total lot size.
In S3, we can go SHORT with a maximum of 20% of the total lot size, or go LONG with a maximum of 30% of the total lot size.
In S4, we should only be taking LONG trades, with a maximum of 40% of the total lot size.
With our $5,000 account example, this means that:
In S1, we can go SHORT with a maximum of 1.4 mini lots (40% of 3.5 mini lots)
In S2, we can go SHORT with a maximum of 1.05 mini lots (30% of 3.5) or go LONG with a maximum of 0.7 mini lots (20% of 3.5)
In S3, we can go SHORT with a maximum of 0.7 mini lots, or go LONG with a maximum of 1.05 mini lots.
In S4, we can go LONG with a maximum of 1.4 mini lots.
Note that these percentages are are maximum amounts. The actual trading lot size would depend on your personal tolerance for risk, as well as the fundamental bias.
The Influence of Fundamental Bias on Lot Size[divider]
When the bias is UP, we want to be more aggressive going LONG and cautious going SHORT.
When the bias is DOWN, we want to be more aggressive going SHORT and cautious going LONG.
When the bias is NEUTRAL, we have neither preference for going SHORT or LONG.
With this in mind, we can set an appropriate trading lot size based on the fundamental bias.[divider_padding]
Fundamental Bias: Up[divider]
When the bias is UP, my preferred trading lot size is:
When the bias is UP, I will not SHORT in S3, and would prefer trading a smaller lot size for any SHORT trades taken in S1 and S2.
Here is where you will exercise your own judgment. If the technical uptrend is strong, you may not even want to go SHORT in S2! It is up to you to adapt to the real-time market situation.
Please note: this is the ONLY area where subjectivity may be required. Everything else we’ve discussed in The Framework and The Account modules must be followed strictly.
Do not trade any larger than 7 times your account capital (all trades combined).
Do not enter trades closer than 0.7% of the pip-distance of the currency value, from each other.
Do not trade more than the maximum allowable percentage within the appropriate sections S1 – S4.
These are rules that work together to safeguard the health of our trading account. Taking a big loss is like a tragic car accident: it doesn’t happen often, but when it does, it’s likely we won’t be able to fully recover from it – it’s too easy for our accounts to lose one-third of its value where it becomes almost impossible to recover from. So please take this module seriously.
Fundamental Bias: Down[divider]
When the bias is DOWN, my preferred trading lot size is:
Similar to the previous example, this is the suggested percentage lot size to be trading when the bias is down. It will be subject to your personal preference, support/resistance, and the prevailing economic situation.[divider_padding]
Fundamental Bias: Neutral[divider]
When the bias is neutral, my preferred trading lot size is:
Do note though, that prices tend to be more volatile (i.e. whip-lashes) in ranging markets. For this reason, I often use pending trade orders instead of market orders to execute my trades.[divider_padding]
Adding On To A Position[divider]
Since we’ll be taking multiple trade entries within the Grid, it’s important that we have a systematic way of adding on to existing open trades.
In general, when prices move in favor of the original trade entry, any subsequent trade entry must be of a smaller lot size. Conversely, when prices move against the original trade entry, any subsequent trade entry must be of a larger lot size.
Sell Trade Example
Let’s say we took a SELL 20% entry in S2 and prices continue dropping in our favor. IF we decide to take another sell trade in S3 (remember: the entry price must be at least 0.7% pip-distance away from the previous entry), we must enter with a lot size smaller than 20%.
This is done so that if prices move against our second trade entry, the net result of both trades would still be positive (up to an extent).
Here’s a different example of a sell trade:
When we have a SELL 20% entry (in S2) and prices move against the trade, any subsequent SELL trades should be of a larger lot size than the first SELL trade. This way, as long as prices remain within the Grid, the likelihood of making a net profit on both trades is high.
The exception to this is when we enter a SELL trade in S1 and prices move against the trade, OUT OF the Grid. In this situation, DO NOT enter another sell trade.[divider_padding]
Buy Trade Example
Let’s say we took a BUY 10% trade in S3. When prices move against the trade and we decide to enter another BUY trade in S4, it must be of a larger lot size than the previous BUY trade.
On the other hand, if we took a BUY 20% trade in S3 and prices move in our favor, the subsequent BUY trade (if any) in S2 must be of a smaller lot size.
[note_box]When prices move in favor of the first trade entry, any subsequent trade entries must be of a smaller lot size. When prices move against the first trade entry, any subsequent trade entries must be of a larger (or at least, equal) lot size.[/note_box]
This method of lot size selection ensures the highest probability of getting a net profit from all trades taken within the Grid.[divider_padding]
Frequently Asked Questions[divider]
Q: Why not just go SHORT 40% in S1 and/or LONG 40% in S4? Why scale in/out of positions gradually?
Great question. There is a three-part answer to this.
The first is that we won’t know if prices will in fact move all the way up to S1 (when the bias is Down), or move all the way down to S4 (when the bias is Up). Remember that these are the extremes of the Grid where prices may not retrace to.
The second is that the chance of making a profit by entering on two levels at 20% each is better than entering once at 40%. With the former, we have more bullets in our gun. If we take the ‘one big bullet’ approach, once we’ve missed the shot, it’s over.
The third is that it is psychologically (and emotionally) easier to manage gradual gains/losses compared to one large gain/loss. Since we’ll be trading for the rest of our lives, the ease at which we can manage our trades will play a large role in enabling us to make objective decisions, which over the long run will significantly affect our trading account.[divider_padding]
Knowing How To Fish[divider]
You now have all the knowledge you need to minimize trading losses and maximize gains. It is now time for you to put this knowledge into practice on a demo account.
Don’t worry if you still haven’t quite gotten the hang of everything just yet. Begin trading on a demo account and whenever you find yourself unsure or stuck, come back to review the relevant modules again. It is through the cycle of practice–review-practice-review that you will make the most progress in your trading education – you’ll almost certainly come across important concepts and tips you missed the first time round.[divider_padding]
Next: Choose A Broker
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