How much to trade within my Risk Threshold?

When you are doing day trading one of your firsts concerns is how much to trade. If this is your first trading experience, you will learn that it is a smart move to have a diversified portfolio; do not put all your eggs in the same nest. Also, do not bet all in one trade; trading is a bet with all the technical analysis behind to reduce the loss risk, but at the end of the day it is still a bet.

With all that said, you will need to define a percentage per bet. For example, I like to bet 2% of my capital per trade. I will talk about how to know how much money that 2% means.

Among all my readings, I have been reading The Ultimate Algorithmic Trading System Toolbox from George Pruitt. The book is more a manual to use a very specific software; but in its first chapters, it has some very interesting thoughts. One of them is about the risk in the portfolio.

To be clear, when you enter a position (buying) you are betting, hence you are putting at risk a quantity. When you are quitting the position (selling) you are getting rid of that risk.

You are the only one who can decide the risk you are willing to accept each trade. As I have said, I am a risky person, I like 2%. Anyway, risking 2% on a BTC_ETH pair is not the same BTC quantity as if you were risking it in on a BTC_DOGE pair.

Here it is the formula:

YYY(XXX_YYY, risk) = (CapitalYYY * risk) / (n * ATRXXX_YYY(14))

Where:

• XXX_YYY is trading pair
• the risk is the desired percentage of capital you want to put at risk, 1 means 100%
• ATR_{XXX_YYY}(14) or Average True Range for the 14 last periods of the XXX_YYY pair. Some authors use 10 or 20 as well.
• Capital_YYY is the total of your capital in YYY currency
• n is the number of ATR's. Some authors use one, others two.I will use one.

This seems a little confusing. Let's do a real example. Currently, I have on Poloniex 0.81211979 BTC in all my portfolio which it is equivalent to 27831 NXT. My BTC_NXT ATR(14) is 0.00000004 [BTC] (equivalent to 0.0013708 NXT). Let's apply the formula:

NXT(BTC_NXT, 0.02) = (27831 * 0.02) / (1 * 0.00013708) = 406059.895

If my understanding is correct, I shouldn't be holding more than 406059.895 NXT. Maybe this is not the best example, it works better when the ATR >= 1.

Good luck!