How can you use a fixed percentage risk model?

A fixed percentage risk model is a simple and effective way to manage your risk and position size in technical analysis. It allows you to adjust your trade size according to your account balance and the volatility of the market. In this article, you will learn how to use a fixed percentage risk model and what are its benefits and limitations.

1 What is a fixed percentage risk model?

A fixed percentage risk model is a risk management and position sizing method that determines how much of your account you are willing to risk on each trade. The basic formula is: Trade size = Account balance x Risk percentage / Stop loss size For example, if you have a $10,000 account and you want to risk 1% on each trade, and your stop loss is 50 pips, your trade size would be: Trade size = $10,000 x 0.01 / 50 = $2 per pip This means that you would buy or sell 2 micro lots (0.02 standard lots) of the currency pair you are trading.

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Nitin Choudhary

IIM Mumbai
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A fixed percentage risk-model is where you risk a fixed percentage of your trading account on each trade. In this approach the trade size is variable and it depends on how far away is the invalidation level of your idea. The closer the invalidation (Stop-Loss) to the Entry, the larger the position size. The further away the invalidation, the smaller the position size. Thumb rule for quick calculation is to calculate how far away is the Stop-Loss from Entry in percentage. Then divide your account size with that number. Eg. On a $10,000 account if the Stop-Loss is 2% away from the entry, in fixed percent risk model, trade size = $10,000/2 = $5000. And if the Stop-Loss is only 0.5% away from entry then trade size = $10,000/0.5= $20,000.

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2 What are the benefits of a fixed percentage risk model?

A fixed percentage risk model offers several advantages for technical analysis traders. It helps to preserve capital and avoid large losses, as well as adapting to your account balance and the market conditions. This reduces emotional stress and the temptation to overtrade or revenge trade, since you have a clear and consistent rule to follow. Additionally, it allows you to compare performance across different markets, time frames, and strategies, since the same risk parameter is used.

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Nitin Choudhary

IIM Mumbai
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A fixed percentage risk model is a very good way for a beginner or intermediate trader to completely remove emotion out from their risk management. It makes the risk management process very mechanical and one doesn't depend on their confidence (an emotion affected by biases) to take risks on each trade. Irrespective of how a trader 'feels' the risk per trade is always constant and emotion free. This prevents an account from having large drawdowns in case the trade idea goes against the trader's analysis. This approach also instills discipline in a trader and also makes it easier to backtest different strategy that one has executed in the past.

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3 What are the limitations of a fixed percentage risk model?

A fixed percentage risk model is not perfect and has some drawbacks that you should be aware of. For instance, it doesn't take into account the quality of your trade entries, exits, and signals, which can influence your reward-to-risk ratio and expectancy. Additionally, it doesn't consider the correlation between your trades and the diversification of your portfolio. This means you may be exposed to more risk than you think if trading multiple pairs that move in the same direction or have similar drivers. Moreover, it may lead to over-leveraging and margin calls if you use a high risk percentage or a small stop loss size, so always check your margin requirements and leverage ratio before placing a trade.

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4 How to choose your risk percentage and stop loss size?

When using a fixed percentage risk model, it is essential to decide how much to risk on each trade and how wide to set your stop loss. This depends on your personal risk tolerance, trading style, and objectives. Generally speaking, a comfortable risk percentage range is between 0.5% and 2%. However, you should adjust this according to your preferences and experience. Additionally, your stop loss should be based on the technical analysis of the market rather than the risk percentage. Support and resistance levels, trend lines, moving averages, or other indicators can be used to determine your stop loss size. Moreover, you should use the formula to calculate your trade size and make sure it is within margin and leverage limits. A position size calculator or a spreadsheet can help with this quickly and accurately.

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Toni Lazarev

Msc. Monetary Economics, Finance and Banking
(edited)
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I don't want to use fixed stops. The percentage of my stop is an output of my actual gains. For instance, if I've made about a 10% profit on trades I've won and I've been profitable in half of my trades over the past year, I can't risk losing 10%, because I won't have an edge. I should limit my risk to a smaller percentage, like 5%. If my usual gain is only 4%, then I should limit my losses to maybe 2%. But if I come to this conclusion, it means the market is very choppy, and it's time to trade less. With this approach, the amount of risk I take depends on the actual results I've had. This approach protects me in a choppy environment and improves my batting average.

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5 How to use a fixed percentage risk model in practice?

Once you have chosen your risk percentage and stop loss size, you can use a fixed percentage risk model to plan and execute your trades in technical analysis. To do this, you must first identify a trading opportunity based on your technical analysis strategy and criteria. Then, you need to determine the direction, entry point, target point, and stop loss point of your trade. After that, calculate your trade size using the formula above and check your margin and leverage levels. Once you’ve done that, place your order with the appropriate trade size, stop loss, and take profit levels. As the trade progresses, monitor it and adjust it if necessary according to your technical analysis rules and market conditions. When the trade reaches its target point or stop loss point or when your technical analysis signals a change in market trend or momentum, close it. Finally, record the details of the trade and its results in your trading journal and review them periodically.

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6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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How can you use a fixed percentage risk model?

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1 What is a fixed percentage risk model?

2 What are the benefits of a fixed percentage risk model?

3 What are the limitations of a fixed percentage risk model?

4 How to choose your risk percentage and stop loss size?

5 How to use a fixed percentage risk model in practice?

6 Here’s what else to consider

Technical Analysis

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How can you use a fixed percentage risk model?

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5

6

1 What is a fixed percentage risk model?

2 What are the benefits of a fixed percentage risk model?

3 What are the limitations of a fixed percentage risk model?

4 How to choose your risk percentage and stop loss size?

5 How to use a fixed percentage risk model in practice?

6 Here’s what else to consider

Technical Analysis

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