In this post, I’ll share why I believe the percent risk model of trading is not the best approach and introduce an alternative method that has worked for me and many others. There are two popular risk models in trading: the percent risk model and the fixed dollar risk model.
Understanding the Percent Risk Model
The percent risk model involves a trader risking a certain percentage of their account size for any given trade. For example, a trader may decide not to lose more than 2% of their account size in any trade. As the account size grows or shrinks, the dollar amount risked also changes accordingly.
The Fixed Dollar Risk Model: A Better Alternative
In the fixed dollar risk model, a trader determines a specific dollar amount they’re willing to lose in any given trade. Regardless of whether the account size grows or shrinks, the trader sticks to this dollar amount, making it fundamentally different from the percent risk model.
Evaluating the Two Models: A Trading Simulation
To compare these two models, I conducted a trading simulation, assuming a starting account size of $10,000 and a win rate of 40%. For the percent risk model, I used a 2% risk per trade, while for the fixed dollar model, I used a $200 risk per trade. After simulating 30 trades, the fixed dollar model consistently outperformed the percent risk model.
Additional Benefits of the Fixed Dollar Risk Model
There are other benefits to using the fixed dollar risk model:
- Faster Recovery from Drawdowns: Drawdowns are inevitable, but the fixed dollar model helps traders recover faster than the percent risk model.
- Better Control of Emotions: With the fixed dollar model, you know exactly how much you’re risking per trade, which can help to keep your emotions in check.
I hope you found this information helpful and consider implementing these insights into your trading strategy. If you’d like to see other videos that will help you become a profitable trader based on my experience, check out the videos on my YouTube channel.
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