Fixed Fractional Method

Fixed Fractional Method
The Fixed Fractional Method is One of the Most Well-Known, Popular Money Management Methods in the Trading Industry

The Fixed Fractional Method is One of the Most Well-Known, Popular Money Management Methods in the Trading Industry And it is One of the Most Misunderstood

There is a Proper Place for the Fixed Fractional Method. But in Order to Know What that Proper Place is, You Need to Understand How it Works and What the Ramifications are of the Method

Fixed Ratio Method No Compounding

Switch Where the Equity Lines Cross Fixed Ratio Method No Compounding

Today, as We Continue to Build a Foundational Understanding of Money Management, We Will Concentrate on Understanding What the Fixed Fractional Strategy and Why the Compounding is Disproportionate at the Beginning From the End

This is Critical in Understanding How to Properly Apply Money Management to Your Own Trading.

I Mentioned the Term “Disproportionate”. Keep this in Mind as We Go Through the Strategy

The Fixed Fractional Method States That I am Going to Risk x% of My Account on Every Trade

If I Have $100,000 Account, Most Traders, Brokers and Gurus Will Tell You Never to Risk More Than 1% - 3% (at the most) of Your Account on Any Given Trade.

Forget the Fact That This is Inefficient From the Beginning. This Recommendation is Made Without Regard for the Type of Strategy That is Being Traded, or for the Risk Tolerance Levels of the Traders, or a Host of Other Things That Need to be Taken Into Consideration Before Making a Money Management Decision

For Example, What if Your Risk Tolerance Level is a Maximum Drawdown of $10,000, And Your Strategy is Only 50% Accurate?

For Example, What if Your Risk Tolerance Level is a Maximum Drawdown of $10,000, And Your Strategy is Only 50% Accurate? Loss 1 = $3,000 Loss 2 = $2,910 Loss 3 = $2,822 Account = $91,268

Loss 1 = $3,000 Loss 2 = $2,910 Loss 3 = $2,822 Account = $91,268 Are You Really Going to Take the Next Trade?

More Information is Needed to Make a Proper Money Management Decision Your Overall Objective Your Risk Tolerance Levels Your Short Term Goals Your Long Term Goals

And… Strategy Profit Potential Strategy Maximum Drawdown Expectations Average DD to Maximum DD Ratio Accuracy Rate Average Winner Average Loser Largest Loser

Proper Money Management Decisions are Inextricably Linked to All of These Things

What is the Fixed Fractional Method Actually Doing?

Let’s Say I Have a Stock Trading Method Where My Stop Loss on the Next Trade is Going to Be $ That Means I am Risking $300 Trading 100 Shares of Whatever Stock I Might be Trading

If I Have $100,000 Account and I Am Risking 3% of My Account on Any Given Trade, I Would Then Trade 1,000 Shares on the Next Trade. ($3,000/$300 = 10 Units, or 1,000 Shares)

Translated Another Way “100 Shares for every $10,000 in the Account”

1% = 100 Shares for Every $30,000 in the Account 2% = 100 Shares for Every $15,000 in the Account 2.5% = 100 Shares for Every $12,000 in the Account 3% = 100 Shares for Every $10,000 in the Account

1% = 100 Shares for Every $30,000 in the Account This Means You Start Out Trading 300 Shares Where the Maximum Loss is $300 per 100 Shares

1% = 100 Shares for Every $30,000 in the Account And You Don’t Go to 400 Shares Until the Account Reaches $120,000

1% = 100 Shares for Every $30,000 in the Account You Go to 500 Shares at $150,000

1% = 100 Shares for Every $30,000 in the Account $100,000 = 300 Shares $120,000 = 400 Shares $150,000 = 500 Shares $180,000 = 600 Shares $210,000 = 700 Shares $240,000 = 800 Shares Etc.

1% = 100 Shares for Every $30,000 in the Account If the Average Winner Was $5 per Share, Average Loser $3 per Share and Accuracy Rate = 50% It Would Take Approximately 67 Trades Just to Start Compounding

Fast Forward to $480,000 Trading 1,600 Shares and the Next Increase Level is 1,700 Shares at $510,000. It Would Take Approximately 18 Trades to Increase to the Next Level

Fast Forward to $900,000 Trading 3,000 Shares and the Next Increase Level is 3,100 Shares at $930,000 It Would Take Approximately 10Trades to Increase to the Next Level

At the Beginning, It Take 67 Trades to Make One Single Increase. As it Grows to $900,000, It Only Takes 10 Trades to Make the Next Increase

This is Disproportionate

With This Example, The Stop Loss is at $ This Means in Order to Not Violate the 1% Risk on Any Given Trade, The Minimum Account Size to Trade This Strategy is $30,000

At $30,000 You Would Trade 100 Shares And Increase to 200 Shares at $60,000

At $30,000 You Would Trade 100 Shares And Increase to 200 Shares at $60,000 How Many Trades to Make the First Increase?

At $30,000 You Would Trade 100 Shares And Increase to 200 Shares at $60,000 How Many Trades to Make the First Increase? If You Guessed 300, You Would be Absolutely Correct.

At $30,000 You Would Trade 100 Shares And Increase to 200 Shares at $60,000 How Many Trades to Make the Three Increases?

At $30,000 You Would Trade 100 Shares And Increase to 200 Shares at $60,000 How Many Trades to Make the Three Increases? 550

After 1,120 Trades, Without Compounding, There is $112,300 in Net Profits Compounding According to This Fixed Fractional Method Would Produce $720,000 in Profits After 1,120 Trades

After 500 Trades, Without Compounding, There is $50,300 in Net Profits

After 500 Trades, Without Compounding, There is $50,300 in Net Profits Compounding According to This Fixed Fractional Method Would Produce Only $90,000 in Profits

The First $50,000 in Non-Compounded Only Adds an Additional $40,000 in Profits by Compounding The Second $50,000 in Non-Compounding Profits Adds An Additional $680,000 in Profits by Compounding.

At the Beginning You Have to Double Your Account Size to Double Your Trade Size…

You Have to Double Your Account Size to Double Your Trade Size… And That is True With Every Application of the Fixed Fractional Method in Every Circumstance When Starting Out With the Minimum Account Size to Trade the Minimum Trade Size

The Main Issue With a Conservative Fixed Fractional Method is That it is Entirely Too Slow (Inefficient) at Benefiting from Any Compounding

And When is Compounding Most Beneficial to Smaller Accounts?

And When is Compounding Most Beneficial to Smaller Accounts? At the Beginning.

The Only Answer (Within the Framework of the Fixed Fractional Method) is to Increase the % of the Account to Risk on Each and Every Trade

The Only Answer (Within the Framework of the Fixed Fractional Method) is to Increase the % of the Account to Risk on Each and Every Trade And in Most Cases, That Has to be a Significant Increase in Order to Achieve Early Compounding

For Example, Risking 10% on Each Trade Would be Risking $10,000 of a $100,000 Account on a Single Trade, or 3,300 Shares.

Most Traders I Know Have No Desire to Take the Kind of Risks Required Here. (Almost 30% of the Account on a String of 3 Losers in a Row)

In Other Words, to Address the Inefficiency at the Beginning with the Fixed Fractional Method, You Then Violate the Very First Rule of Proper Money Management Decisions…

In Other Words, to Address the Inefficiency at the Beginning with the Fixed Fractional Method, You Then Violate the Very First Rule of Proper Money Management Decisions… Survival

Further, This Means That at Any Given Time No Matter How Much Compounding Has Taken Place, You Are Always Risking Almost 30% of Your Account on a String of 3-Losses

There is No Middle Ground. The Fundamental Flaw of the Fixed Fractional Method is That the Increase Rate is Highly Disproportionate.

Switch Where the Equity Lines Cross Fixed Ratio Method No Compounding

Optimal f The Optimum Fixed Fraction to Trade in Any Given Scenario.

Optimal f In the Coin Flipping Game, Optimal f Was 25%
At 25% Risk Per Trade Produced the Greatest Profit After Compounding

Optimal f Below 25% Produced a Smaller Profit and Above 25% Produced a Smaller Profit

(50% Correct With a 2:1 Win/Loss Ratio)
Optimal f In Most Cases, Any Strategy Worth Trading, is Going to Have an Optimal f Around That Level (50% Correct With a 2:1 Win/Loss Ratio)

Optimal f If in the Future, the Stats Change for the Worse and You Are Trading Optimal f, That Number Was Based on Expectations, Not Actual Results, and During the Negative Run, Optimal f May Have Actually Been Much, Much Lower (Like 7% - 8%)

Optimal f Anytime You See This Referenced, Completely Ignore it, It Has No Place in Practical Application

Fixed Ratio Method The Foundation Has Now Been Properly Laid and Starting in Lesson 5, We Will Go Over the Fixed Ratio Method and Begin to Make Practical Applications of it in Trading

Fixed Fractional Method

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