Fixed fractional money management is a money management technique used by many traders with great success. As with all money management strategies, there are pros and cons, and not all money management strategies are suitable for all traders. This article can help you decide whether or not fixed fractional money management is right for you.
Fixed fractional money management is one of the most common anti-martingale money management strategies that traders use. In fact, many money management strategies are based on fixed fractional money management. Fixed fractional money management involves risking a fixed percentage of equity on any given trade. Traders using fixed fractional money management select a percentage of equity between 0% and 1% to risk on a given trade. Stock traders, or traders trading larger accounts, typically use a smaller percentage, while Futures and Forex traders will often use a higher percentage to determine a fixed dollar amount per contract when trading.
This money management method requires that in order to increase from one to two contracts, a trader would need a profit that reflects the fraction of the account that is being traded. For example, if a trader used 1.0 of $10,000 he would trade only one contract until his account reached $20,000. When the account reached $20,000, the trader would be able to trade two contracts. This may seem like a daunting scenario, but look at what happens when you move from nine to ten contracts using the same proportion. Our trader would still require a $10,000 profit, but that $10,000 profit would come from nine contracts. This means that a trader would only need to average approximately $1,100 per contract in order to increase his position size.
Using this method will give you a slower increase of your position size early on, and unequal achievement as your account grows. Because of this, a trader has to make $10,000 trading one contract very early on in the process in order for this method to work. However, after a short time of increasing position sizes and making profits he would be able to trade nine contracts to make that same $10,000, but with much more ease. This is what is known as unequal achievement.
Another disadvantage of this method is that the drawdown will stay the same regardless of position size. It does not matter if you are trading a $10,000 or $100,000 account, or if you are trading one contract or one hundred contracts. If you can expect a certain drawdown per contract, it is going to be the same percentage across the board. Another disadvantage is that with smaller accounts it will take longer for this type of money management to be effective. One must also keep in mind while using this method, that the number of contracts in a larger account can fluctuate significantly. If you are trading a $100,000 account and using .05 as your fraction, you might find that as your account is growing and decreasing, the number of contracts is fluctuating all over the place.
Although fixed fractional money management is a very easy approach to money management, and although many traders in the Futures, Forex, and Stock markets find it very effective, there may be more effective ways to incorporate money management for the beginning trader.
Markus Heitkoetter is the author of the international bestseller “The Complete Guide To Day Trading (www.rockwelltrading.com) and a professional day trading coach. For more free information on day trading visit his website http://www.rockwelltrading.com