Part I. Risk Management Framework
Commander in Pips: Gradually we are moving to the end of our school and most of the rest of the chapters will be dedicated to different kinds of management and corresponding to trading stuff. Still there will not be a small amount of chapters ahead. Now the time has come to shed some light on risk management. We very often have mentioned this topic with different chapters across the school but never talked about it in detail. Now will try to fill this gap.
Pipruit: That’s great. Actually this is one of the main parts in my trading system that demands more clarification.
The same is with trading. Since we intend to start a business and we want to make money on it – we also have to know how safely avoid unnecessary loss and eliminate possible scenarios where such losses could appear. That is risk management. This topic is crucially important, since saving earned profit is as hard to keep as it was to earn, or even harder.
Commander in Pips: That’s why if some trader just approximately counts up in his head acceptable loss and in hasty rush runs to use his trading software, then we might say that his plans are in a bad way. This is more a gambling plan rather that a serious and longterm business startup plan.
We even could say more clearly – trading without money/risk management is gambling…
Pipruit: Well, but I have a chance to get a jackpot in Vegas…
Pipruit: Well, I suppose because they earn more than they lose…
Pipruit: Hm, I don’t think so. Gambling is a big business, so with casinos, it has to be planned carefully.
Commander in Pips: That is risk and money management. A simple gambler could win an occasionally jackpot, but if he will try it again – he will spend all of this prize and have to add more to do it. Other gamblers also win from time to time but they always will stand in some loss, because statistics are not on their side.
You probably know that there were some persons who have won in casinos, but what did they do? They apply statistics and count every step. This can let a few of them find ways to win.
So, if you want to stay profitable in the long run, then you have to get statistics on your side and you have to apply such things that will turn the equilibrium in your favor at any possibility and any trade.
Pipruit: Nice explanation sir. I think I’m starting to understand…
Commander in Pips: That’s good. So, if we have come to the conclusion that money management is must, from what should we start? I offer to move from general to specific. General is overall capitalization and planning of trading as a business. Here I have to send you to the chapter, where we’ve discussed this in details in Chapter 29. Part II. >>
When you’ve estimated how much money you will need for starting this business and support it in longterm, then can talk about the specific issue – how much money should be in your trading account…
Pipruit: I know this already!
Pipruit: 25 bucks minimum.
Pipruit: Well, I ran through some brokers’ conditions and many of them allow you to open an account with just 25 bucks.
Pipruit: Why?
Let’s suppose that current EUR/USD rate is 1.3480. Then we might say that with 99% probability rate will hold in the range (1.3480  1.3480*0.7%*3) – (1.3480+1.3480*0.7*3%) or 1.3763 – 1.3197, so your drawdown on position will not exceed 280 pips (since we need only a negative one). Ok, with 95% probability it will not exceed even 190 pips per day. Is it too much or too few?
Pipruit: Hm, 180 pips risk a day at minimum seems rather solid to me.
Pipruit: 1000*0.0188 = 18.8 bucks with 95% probability and 28 bucks with 99% probability…
Pipruit: Wait a minute, and how I can trade with just 25 bucks?
Pipruit: So, what I have to do?
Commander in Pips: You need a bit more money to start. Let’s calculate the absolute minimum as a startup sum on forex to trade. We will give the simplest approach to calculation. Later, you may find and apply some more sophisticated approach – there are a lot of books dedicated to risk management.
So, our rule is to not risk more, than 1 % from initial total assets in every trade. Hence we will be able to make 100 losing trades in a row. Our maximum loss, according to minimum daily volatility is 280 pips. If the minimum lot that we can trade is 0.01. Hence our minimum assets are: (100,000*0.01*280pips)/1% = 2800 USD. But this is a minimum volatility. Maximum volatility, at least during recent couple of years is 4 times higher. Hence our assets should be at average (2800+11,200)/2 ~ 7000 USD. That is a normal startup sum. If you intend to trade with, say, 0.1 lot, you will need $70K. Intraday charts have smaller volatility, so if you want to trade intraday you may need smaller assets to start with. So, this is some material to think about.
Commander in Pips: Probably you do. But now imagine how much you will earn, if the market will show a 100 pip move in your favor – 100,000*0.001*0.0100 = 1$. Probably this is a true prize for your hard work on the market. Maybe it’s better to make bet for some 90% Manchester United win over a weak team with the smallest ratio, say, 1.1 – you’ll get about 2.5$ profit. Think about it. You have to feel the results of your hard work, otherwise, you will lose any interest in the trading process.
Prepare to drawdown
Commander in Pips: Every trader should be prepared to deal with possible drawdown of his/her account. This is just a continuation of the previous part. Here is the chart of assets value on an account. The Xaxis shows the number of trades, while the Yaxis assets value. Initially deposited assets were $5000. We see a pretty nice profit picture, but during recent time assets start to fall. The distance between most recent high to most recent low is a drawdown. Here it is $8200 – $7400~ $800. Previous drawdown was very small in 4th trade – just around 50$.
Statistics of this account tells us that the trader has 66.67% of profitable trades and 33.33% of losing trades. If trader will continue work in such manner, he or she should lose no more than 33 trades out of 100. This is a nice ratio. But, can you tell me, to what consequence these trades will come?
Commander in Pips: Most probable that you’re right, but we have to look at a worst case scenario, if they will all come initially. In other words, if the trader will lose 33 trades in a row and only after that do 66 profitable trades come. Statistics of this account also tells us that the average loss trade is $133. Hence, 33*133 = $4,389 will be the approximate drawdown if trader will resume the same performance and trading style. From that standpoint we see that the trader applied acceptable money management, since it assumes that it could make twice more losing trades and some assets will remain in the account still.
Commander in Pips: This is also some insurance for some case if something will change in the trading system or style, so that the trader could not support the same performance and it will become worse. Particularly due to that reason we advise you to risk not more than just 1.5 % of assets in each trade. This will allow you to make 66 losing trades in a row before you will devastate your account. That is a sufficient balance, since we hope that you will get the point that something is wrong if you will make 1020 losing trades in a row. A wise trader understand that he/she will not win every trade, so he/she has to plan risk so that there will be some reserves for really bad times.
Commander in Pips: Well, although we have shown simplest way, actually you’re right. You have to risk a smaller part of your assets, if you have lost something already. In fact, your percent risk will remain the same, while your dollar risk will become lower.
Commander in Pips: You need a bit more money to start. Let’s calculate the absolute minimum as a startup sum on forex to trade. We will give the simplest approach to calculation. Later, you may find and apply some more sophisticated approach – there are a lot of books dedicated to risk management.
So, our rule is to not risk more, than 1 % from initial total assets in every trade. Hence we will be able to make 100 losing trades in a row. Our maximum loss, according to minimum daily volatility is 280 pips. If the minimum lot that we can trade is 0.01. Hence our minimum assets are: (100,000*0.01*280pips)/1% = 2800 USD. But this is a minimum volatility. Maximum volatility, at least during recent couple of years is 4 times higher. Hence our assets should be at average (2800+11,200)/2 ~ 7000 USD. That is a normal startup sum. If you intend to trade with, say, 0.1 lot, you will need $70K. Intraday charts have smaller volatility, so if you want to trade intraday you may need smaller assets to start with. So, this is some material to think about.
Pipruit: I see. Sounds logical, but sir, I’ve heard that there are brokers that allow you to choose any lot size. So, if I choose 0.001 lot, probably I can trade with just 25 bucks.
Prepare to drawdown
Commander in Pips: Every trader should be prepared to deal with possible drawdown of his/her account. This is just a continuation of the previous part. Here is the chart of assets value on an account. The Xaxis shows the number of trades, while the Yaxis assets value. Initially deposited assets were $5000. We see a pretty nice profit picture, but during recent time assets start to fall. The distance between most recent high to most recent low is a drawdown. Here it is $8200 – $7400~ $800. Previous drawdown was very small in 4th trade – just around 50$.
Pipruit: Hardly sir, but I suppose that they will spread somehow among profitable trades…
Commander in Pips: Most probable that you’re right, but we have to look at a worst case scenario, if they will all come initially. In other words, if the trader will lose 33 trades in a row and only after that do 66 profitable trades come. Statistics of this account also tells us that the average loss trade is $133. Hence, 33*133 = $4,389 will be the approximate drawdown if trader will resume the same performance and trading style. From that standpoint we see that the trader applied acceptable money management, since it assumes that it could make twice more losing trades and some assets will remain in the account still.
Commander in Pips: This is also some insurance for some case if something will change in the trading system or style, so that the trader could not support the same performance and it will become worse. Particularly due to that reason we advise you to risk not more than just 1.5 % of assets in each trade. This will allow you to make 66 losing trades in a row before you will devastate your account. That is a sufficient balance, since we hope that you will get the point that something is wrong if you will make 1020 losing trades in a row. A wise trader understand that he/she will not win every trade, so he/she has to plan risk so that there will be some reserves for really bad times.
Pipruit: Sir, some idea has come to me, I’m just wondering – since our assets becomes lower with each losing trade – should we apply the 2% rule for initial assets value or to current assets value? In other words, should we reduce trading lot size if we assume that stoploss distance will remain constant?
Pipruit: But sir, in this case it will be much harder to return all loses back, since with smaller positions we will have to earn more pips to return previous losses.
Commander in Pips: Absolutely. That’s why it is so important not just earn pips, but to save them. This is even more important, I suppose. To illustrate it, let’s take a look at following table:
So, from table you can see, that even if you will adjust loss value proportionally to the rest of your assets, you will have to earn more of a percent to get back to breakeven than your drawdown is. For example, after 20 loss trades your drawdown will be 33% from initial assets value. But since now you have just $6,676, you have to earn almost 50% to return back to 10,000$. Ultimately if your drawdown will be 90% and you will rest with just $1000, then how much you will have to earn in percents to return back to $10,000?
Commander in Pips: Yes, this is a tough task to do – make a 9x times of your account. So, let’s take a look at this process visually with the following chart:
You can see, that although loss develops proportionally to initial deposit, it is not proportionally to the rest of assets – you have to return more proportionally as you lose more of your account.
Commander in Pips: Absolutely. That’s why when you’ve got a solid drawdown it will be harder and harder to return all loss back to breakeven, i.e. initial assets value.
Couple of words about Reward/Risk ratio
Commander in Pips: Here is another issue that lets you understand why a trading journal and statistical numbers are important. In fact, Reward/Risk ratio is a relationship between your potential loss and potential profit in each trade. For example, if you’ve placed stop loss to 50 pips, while your profit has placed at 100 pips, then your Reward/Risk ratio is 2:1 or simply 2. Now, let’s understand why statistics are so important here  mostly because there is a balance between your system's effective strength and your reward/risk ratio. For example, if your trading system shows 50% of profitable trades, that your reward/risk ratio should be greater than 1. Otherwise you will stand at or below breakeven and will not earn anything. On following table we will show edge reward/risk ratios depending on your system % Win trades ratio:
This is very simple to understand. For instance, if you win just in a single trade from ten possible, you have to earn so, that compensate all loss in other 9 trades and get some profit. So you have to earn, say, at least 100 pips in 1 trade and lose no more than 90 pips in the 9 rest.
Actually, although we’ve pointed out that if you have super efficient system with 90 % winning trades you can let yourself to use just 0.1 reward/risk ratio – this is not wise. Statistically yes, you will earn profit, but logically there is no sense to take Reward/risk ratio less than 1 in any trade. A ratio of less than 1 skewed chances of success against you with many repetitions of such trades. A trader’s major task is to increase probability of success in any trade. That’s why he/she should not apply Reward/risk ratio less than 1 in any trade. Usually it is recommended to apply a 2:1 or even 3:1 ratio, but we have to point out that this is not a hardrock ratio that could not be changed. If you will base your trades on a constant ratio this will lead to some problems – your targets could be too far, relative to what analysis tells you, you will trade too big of lots, or place too tight of stoploss orders. Reward/risk ratio is a consequence but not the reason.
We recommend dealing with it as follows. Make your analysis of the market and estimate crucial levels for your scenario. Let’s suppose you intend to enter Long on EUR/USD from 1.3520 level on hourly chart and you have estimated that if market will break down 1.3470 area – this will significantly increase the probability of downward acceleration and your bullish scenario will have vanished. So, your crucial level is 1.3470 + some room. Hence, you will place stop somewhere around 1.3450 probably. Your risk is 80 pips.
Now estimate your target. Let’s suppose that nearest 0.618 target of some ABCD extension stands at 1.3590 and initially you intend to take it. Here is your reward risk ratio is 7:8<1, and probably you have to reject this trade as ineffective.
If market will show some deeper retracement and your context for a long trade will still hold, say to 1.3490, then you can try it, because now you will have 100:40=2.5>1 reward/risk ratio.
The major mistake that many traders do with reward/risk calculation is force it to context, or force orders’ placement to reach a ratio greater than 1. This is quite unwise. Reward/risk ratio is a statistical measure but not a tool that brings you money. You may reach a ratio>1 by artificially placing orders, take bad trades and lose money – will it be nice, will you be happy that you at least had ratio>1? I don’t think so. This ratio is a tool, but not a goal to achieve. It lets you escape unwelcome trades. So use it accordingly. Besides, acting like this you break your trading system and do not follow the trading plan – one mistake triggers others.
Commander in Pips: Absolutely. That’s why it is so important not just earn pips, but to save them. This is even more important, I suppose. To illustrate it, let’s take a look at following table:
Trade #  Assets Value  Supposed 2% Loss  Loss, %  Distance to Breakeven,% Compared to the Rest of Assets 

0  10,000  200  0%  0% 
1  9,800  196  2%  2% 
2  9,604  192  4%  4% 
3  9,412  188  6%  6% 
4  9,224  184  8%  8% 
5  9,039  181  10%  11% 
6  8,858  177  11%  13% 
7  8,681  174  13%  15% 
8  8,508  170  15%  18% 
9  8,337  167  17%  20% 
10  8,171  163  18%  22% 
11  8,007  160  20%  25% 
12  7,847  157  22%  27% 
13  7,690  154  23%  30% 
14  7,536  151  25%  33% 
15  7,386  148  26%  35% 
16  7,238  145  28%  38% 
17  7,093  142  29%  41% 
18  6,951  139  30%  44% 
19  6,812  136  32%  47% 
20  6,676  134  33%  50% 
So, from table you can see, that even if you will adjust loss value proportionally to the rest of your assets, you will have to earn more of a percent to get back to breakeven than your drawdown is. For example, after 20 loss trades your drawdown will be 33% from initial assets value. But since now you have just $6,676, you have to earn almost 50% to return back to 10,000$. Ultimately if your drawdown will be 90% and you will rest with just $1000, then how much you will have to earn in percents to return back to $10,000?
Pipruit: 9000/1000 = 900%! That’s almost impossible, especially if we will take into consideration that you’ve lost 90% of your account.
Commander in Pips: Yes, this is a tough task to do – make a 9x times of your account. So, let’s take a look at this process visually with the following chart:
You can see, that although loss develops proportionally to initial deposit, it is not proportionally to the rest of assets – you have to return more proportionally as you lose more of your account.
Pipruit: Yes, now I understand that. The reason is that you stand with less amount of money with each loss, while loss itself remains the same. So you have to earn more in percents on the rest of your assets.
Couple of words about Reward/Risk ratio
Commander in Pips: Here is another issue that lets you understand why a trading journal and statistical numbers are important. In fact, Reward/Risk ratio is a relationship between your potential loss and potential profit in each trade. For example, if you’ve placed stop loss to 50 pips, while your profit has placed at 100 pips, then your Reward/Risk ratio is 2:1 or simply 2. Now, let’s understand why statistics are so important here  mostly because there is a balance between your system's effective strength and your reward/risk ratio. For example, if your trading system shows 50% of profitable trades, that your reward/risk ratio should be greater than 1. Otherwise you will stand at or below breakeven and will not earn anything. On following table we will show edge reward/risk ratios depending on your system % Win trades ratio:
% Won Trades  Minimum Reward/Risk Ratio for Every Trade 

10  must be greater than 9:1 
20  must be greater than 4:1 
30  must be greater than 2.3:1 
40  must be greater than 1.5:1 
50  must be greater than 1:1 
60  must be greater than 0.67:1 
70  must be greater than 0.43:1 
80  must be greater than 0.25:1 
90  must be greater than 0.11:1 
This is very simple to understand. For instance, if you win just in a single trade from ten possible, you have to earn so, that compensate all loss in other 9 trades and get some profit. So you have to earn, say, at least 100 pips in 1 trade and lose no more than 90 pips in the 9 rest.
Actually, although we’ve pointed out that if you have super efficient system with 90 % winning trades you can let yourself to use just 0.1 reward/risk ratio – this is not wise. Statistically yes, you will earn profit, but logically there is no sense to take Reward/risk ratio less than 1 in any trade. A ratio of less than 1 skewed chances of success against you with many repetitions of such trades. A trader’s major task is to increase probability of success in any trade. That’s why he/she should not apply Reward/risk ratio less than 1 in any trade. Usually it is recommended to apply a 2:1 or even 3:1 ratio, but we have to point out that this is not a hardrock ratio that could not be changed. If you will base your trades on a constant ratio this will lead to some problems – your targets could be too far, relative to what analysis tells you, you will trade too big of lots, or place too tight of stoploss orders. Reward/risk ratio is a consequence but not the reason.
We recommend dealing with it as follows. Make your analysis of the market and estimate crucial levels for your scenario. Let’s suppose you intend to enter Long on EUR/USD from 1.3520 level on hourly chart and you have estimated that if market will break down 1.3470 area – this will significantly increase the probability of downward acceleration and your bullish scenario will have vanished. So, your crucial level is 1.3470 + some room. Hence, you will place stop somewhere around 1.3450 probably. Your risk is 80 pips.
Now estimate your target. Let’s suppose that nearest 0.618 target of some ABCD extension stands at 1.3590 and initially you intend to take it. Here is your reward risk ratio is 7:8<1, and probably you have to reject this trade as ineffective.
If market will show some deeper retracement and your context for a long trade will still hold, say to 1.3490, then you can try it, because now you will have 100:40=2.5>1 reward/risk ratio.
The major mistake that many traders do with reward/risk calculation is force it to context, or force orders’ placement to reach a ratio greater than 1. This is quite unwise. Reward/risk ratio is a statistical measure but not a tool that brings you money. You may reach a ratio>1 by artificially placing orders, take bad trades and lose money – will it be nice, will you be happy that you at least had ratio>1? I don’t think so. This ratio is a tool, but not a goal to achieve. It lets you escape unwelcome trades. So use it accordingly. Besides, acting like this you break your trading system and do not follow the trading plan – one mistake triggers others.
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Table of Contents
 Introduction
 FOREX  What is it ?
 Why FOREX?
 The structure of the FOREX market
 Trading sessions
 Where does the money come from in FOREX?
 Different types of market analysis
 Chart types
 Support and Resistance

Candlesticks – what are they?
 Part I. Candlesticks – what are they?
 Part II. How to interpret different candlesticks?
 Part III. Simple but fundamental and important patterns
 Part IV. Single Candlestick Patterns
 Part V. Double Deuce – dual candlestick patterns
 Part VI. Triple candlestick patterns
 Part VII  Summary: Japanese Candlesticks and Patterns Sheet

Mysterious Fibonacci
 Part I. Mysterious Fibonacci
 Part II. Fibonacci Retracement
 Part III. Advanced talks on Fibonacci Retracement
 Part IV. Sometimes Mr. Fibonacci could fail...really
 Part V. Combination of Fibonacci levels with other lines
 Part VI. Combination of Fibonacci levels with candle patterns
 Part VII. Fibonacci Extensions
 Part VIII. Advanced view on Fibonacci Extensions
 Part IX. Using Fibonacci for placing orders
 Part X. Fibonacci Summary

Introduction to Moving Averages
 Part I. Introduction to Moving Averages
 Part II. Simple Moving Average
 Part III. Exponential Moving Average
 Part IV. Which one is better – EMA or SMA?
 Part V. Using Moving Averages. Displaced MA
 Part VI. Trading moving averages crossover
 Part VII. Dynamic support and resistance
 Part VIII. Summary of Moving Averages

Bollinger Bands
 Part I. Bollinger Bands
 Part II. Moving Average Convergence Divergence  MACD
 Part III. Parabolic SAR  Stop And Reversal
 Part IV. Stochastic
 Part V. Relative Strength Index
 Part VI. Detrended Oscillator and Momentum Indicator
 Part VII. Average Directional Move Index – ADX
 Part VIII. Indicators: Tightening All Together
 Leading and Lagging Indicators
 Basic chart patterns
 Pivot points – description and calculation
 Elliot Wave Theory
 Intro to Harmonic Patterns
 Divergence Intro
 Harmonic Approach to Recognizing a Trend Day
 Intro to Breakouts and Fakeouts
 Again about Fundamental Analysis
 Cross Pair – What the Beast is That?
 Multiple Time Frame Intro
 Market Sentiment and COT report
 Dealing with the News
 Let's Start with Carry
 Let’s Meet with Dollar Index
 Intermarket Analysis  Commodities
 Trading Plan Framework – Common Thoughts
 A Bit More About Personality
 Mechanical Trading System Intro
 Tracking Your Performance
 Risk Management Framework
 A Bit More About Leverage
 Why Do We Need StopLoss Orders?
 Scaling of Position
 Intramarket Correlations
 Some Talk About Brokers
 Forex Scam  Money Managers
 Graduation!