Fixed Ratio Money Management In Trading
Money management is one of the pillars of Forex trading; coincidentally, it’s also what keeps your trading career alive.
Lousy money management can quickly spiral all of your capital out of control and take you through a road you definitely don’t want to go.
Luckily for you, you’re about to learn about a money management technique that will probably end up saving you a lot of money!
Fixed Ratio is what they call it, and you’re about to know what it is!
What Is The Fixed Ratio Technique?
This technique advocates that the relationship between the number of traded lots and the profits required to increase the position size has to remain fixed. It aims to determine the ideal number of contracts we can trade based on the losses and profits, so that we can have a better performance in the long term.
Ryan Jones developed the Fixed Ratio Method by breaking down the Fixed Fractional method. With the Fixed Ratio Method, a trader looks to place a limit on how much money he/she spend on each contract and before opening a new one. It does so by telling the trader how long he/she should wait (in profits) before opening a new contract.
It has its disadvantages, especially for traders with small accounts. That’s because you have to adjust the size of your positions incrementally, but due to the standardized lot sizes you will be forced to work with, you may find that it won’t always be possible to adjust the contract size in accordance with the Fixed Ratio formula. Another problem could be when you fall on a losing streak. In this case, your position size is going to decrease at the same time.
To give you an example, if your minimum margin for holding a contract is $7,000, you must maintain that amount of capital in your account per contract. That is, if you want to open a second contract, you must have at least $14,000.
It goes on per contract, and the objective is to force you to save a margin to protect your already-earned capital as well as earn your profits to make your account escalate in a fixed and somewhat predictable manner - all without cutting your exposure to the market but rather making it sustainable.
How Does It Work?
The technique is dictated by an established formula that lets you calculate the amount of equity required for you to scale to an extra contact. Ryan Jones introduced the Fixed Ratio methodology with a variable he called delta. With this variable, we can see how aggressive is the MM since these are inversely proportional - the higher the delta, the more conservative the MM will be.
To calculate this Fixed Ratio technique, there is a straightforward formula:
Previous Required Equity + (Current Number Of Contacts x Required Equity Per Contract) = Required Equity For Next Contact
If we take it apart element by element, you have that you must multiply the set required margin (also called Delta) per contract times the amount in open contracts you have right now. To that, you add your already-existing equity, and the result is the amount of money you must have in your account to open an additional contract.
PRE + (CNOC * REPC) = REFNC
- The REPC or Delta is the amount of equity you must have in your account per contract.
- The CNOC is how many contracts you’re trading right now.
- The PRE is the equity available in your account.
- The REFNC is the equity you need to have before you can increase your positions by adding a new contract.
Many people use this money management system as it is a safe way to increase your exposure to the market. You can protect your accumulated profits.
For example, let’s suppose that you have a limit for a future contract of two thousand dollars. This means that if you want to negotiate another deal in addition to this, you would need another two thousand dollars. It means that your delta, in this case, would be two thousand dollars for the calculation of the fixed ratio.
How Can You Apply The Fixed Ratio Method?
Let’s now take a look at a straightforward exercise to demonstrate this formula. Suppose there is a trading account of $40.00 and a delta equal to $4,000. In such a case, it would work as follows:
40.000+1(1*4.000) = 44.000. This $44,000 means that we should increase our trading size to 2 contracts.
44.000 + (2 * 4,000) = 52,000. In the future when we have the 65,000 dollars we can increase our trades to 3 contracts.
The risk of this is the amount of money that the trader may lose in each of these trades increases as his profits increase.
How Can You Use It In Forex Trading?
The numbers are so big because it was originally designed for options and futures, but you can use it in Forex by replacing “contracts” with “positions” and using numbers that match your trading style.
As margin-per-contract is better determined with percentages of your total equity, a scalper’s fixed ratio would be more towards a couple of dollars per position, so he can have more open trades at the same time.
Just remember to lower the number of open positions if your account starts to dip below the minimum requirements!
Why Should You Consider It?
This technique provides a percentage of security and reliability when it comes to knowing how many lots you can reach without exceeding your budget or assuming the risk of another deal with more confidence and with the right capital.
If you didn't use this technique, it could be dangerous as you would be taking risks with all odds against you without you knowing it. It is an effortless and practical technique and has the potential to give you success in your overall trading. So, do not hesitate to try it.