#### Risk/ Reward

The essence of a trailing stop loss is that each time the market moves higher, the risk-reward profile of the trade remains similar to the initial risk reward profit. This is called maintaining the risk/reward profile. A trader should avoid placing a trailing stop loss at levels where they are risking more once they move their stop loss, then they where risking initially. An example of this would be as follows. Let’s say an investor placed a trade on IBM where he was looking to make 6 percentt and willing to risk 3% of a move against him on the trade. After the market moved 2% the trader plans to move the stop loss up to his initial entry price. This strategy would create the same risk-reward ratio since the trader is risking 2% (the difference between the current market which moved 2%) and the planned gain which is an additional 4%. If the trader moved the trailing stop up to 1% below his initial entry point, after the market moved 2%, then the risk-reward profile would be risking 3% (2% to minus 1%) to make 4%, which is a different ratio then the initial risk-reward.

#### Bet Size

Along with stop losses and take profit levels, determining the optimal bet size is a very important part of creating a profitable trading strategy. Sticking to a strategy that preserves a trader’s capital and avoids ruin should be on an inestor’s mind when determining the appropriate capital to place on a trade. There are many mathematical models which include Monte Carlo Simulation and the Kelly rule which help statisticians determine the optimal bet size for a systematic trading strategy. A simulation will allocate an amount of capital to a strategy and historically step through time to determine the best way to allocate capital per trade. Realistically, there are a few potential ways to allocate capital. There is a fixed notional amount that allows a trader to place only a specific amount of capital per trade. This style can become ineffective asa trader’s capital grows or falls and can become unrealistic within a very short period’s needs.

Another style is to have a fixed percentage allocation. The benefit of this style of capital allocation is that it avoids ruin by creating smaller bet sizes as your capital moves lower, but increases and compounds as your capital increases. Since it is very difficult when analyzing a discretionary system to determine if a strategy will have multiple wns or losses in a row, a fixed percentage strategy is a robust style to allocate capital. Another strategy, which is known as pyramiding increases the amount in percentage terms that a trader will risk as the portfolio climbs, and decreases the amount that is allocated as the capital base falls. This strategy works well if the strategy has trends where there are winners or that follow winners or losers that follow losers.

The key to a successful money management style is to preserve your capital and live to see another day. “Bet it all strategies” are bound to fail and they should be avoided at all costs. One way to determine the percent to risk on a trade is to determine your goals prior to beginning to trade a strategy. For example, let’s assumea trader’s goals are to make 10% within a year and h believes that his strategy will generate 10 trades throughout the year, and the strategy generally wins 50% of the time and loses 50% of the time. Also, the strategy usually wins \$2 for every y 1\$ risk. A capital allocation that risks 4% for every 2% risked will generate a return of 10%. (10,000 * 1.04 = 10,400 * .98 = 10,192 * 1.04 = 10,599 * .98 = 10,387 * 1.04 = 10,803 * .98 = 10,587 * 1.04 = 11,010 * .98 = 10,790 * 1.04 = 11,222 * .98 = 10,998) This type of analysis is very important in determining the correct amount of risk to allocate to a trading strategy.