The trading float is the capital you set aside for trading. The amount of money you commit to your float will be dependent on your overall financial position and risk tolerance.

Generally people with larger amounts of capital tend to risk less as a proportion of their capital. However, the value of money is different to everyone and you should tailor your risk to your own personal circumstances by considering some or all of the following:

• Stage of life
• Equity in real estate
• Debt levels
• Ongoing financial commitments
• Income and earning potential

Larger starting floats allow greater flexibility to employ different strategies at the same time. This kind of diversification can lead to profits being distributed more evenly.

As a general rule it is considered prudent to put a smaller amount of capital into higher risk strategies, and larger amounts into lower risk strategies. As you trade, and increase your trading capital, your risk tolerance may change.

You also need to define what you plan to do with your profits. Traders with smaller floats tend to reinvest their profits (i.e. compound) while others may wish to take profits out as a form of income.

The amount of money in your float determines both the number of positions you can have open at any time and the size of each position. Position size ultimately determines profitability, the number of positions you can have open at a time and is a major contributor towards achieving consistency of returns in the long term.

The purpose of the trading float is to allow you to experience a drawdown but remain with enough capital to continue trading. Drawdown is an inevitable consequence of trading and means the loss of equity or the total dollar loss that occurs after several losing trades.

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How do you calculate your float?

When you have no open trades float calculation is easy – it is the amount of money you have available. However, the moment you have an open trade you are faced with a dilemma at what value do I include (if at all) my current portfolio of trades. Some of your choices are listed below:

1. Cash at bank

Major presumption:

You have 100% of your open trade value at risk. This is clearly not the case if you are trading with a stop loss.

Advantage:

Provided you are not using CFDs (or other daily mark to market instruments) this method is conservative and will result in you taking smaller position sizes.

Disadvantage:

Your position sizes are smaller and as a result your overall profitability could be reduced. If you do not have access to leverage you can only enter trades to the maximum cash value of your float.

2. Cash at bank plus market value of all open positions

Major presumption:

You will exit all positions at current market value or higher. This is clearly not the case if you are trading using a trailing stop, as the market value will decrease some way prior to exiting any of your open positions. For those people using CFDs or any other mark to market product this is the equivalent of using your bank balance.

Advantage:

This method will allow you to enter much larger position sizes as a result of your calculated Float value being significantly larger.

Disadvantage:

As the value of your Float could fluctuate significantly from day to day, your emotions and perception of your trading results may swing from extreme highs to extreme lows. This may result in you being less likely to follow your trading plan.

3. Cash plus stop loss valuation of open positions

Major presumption:

You will exit your open positions at your stop loss level. This is unlikely to be the case the majority of the time, due to slippage. Slippage is where you close your open position at a price that is different to your stop loss (i.e. your exit price is above or below your stop loss price). This is the most accurate of all of the Float calculation methods.

Advantage:

Your Float shows a loss on the day you enter the trade. Emotionally this is the easiest time to take the loss. From this point on, you will either exit the position at a slightly greater or smaller loss at your fixed stop or you will track the trade through and lock in more and more profit as the trade progresses. This method also allows you to take slightly larger trade sizes than method 1 and to capitalise on profitable trading streaks and minimise your losses whilst in losing streaks.

Disadvantage:

Non-levered floats – As you are taking slightly larger positions with each trade you will most probably have fewer open positions at a time.

Levered floats (mark to market instruments) – While, the stop loss valuation of open positions is easy enough to identify for your open trades, the Float value (i.e. cash balance portion) is slightly more difficult to calculate. As your cash balance fluctuates every day due to increases and decreases in the value of your open trades (i.e. through the mark to market action of your broker / market maker).

4. Initial Float plus profit or loss from closed trades

Major presumption:

Your Float is your initial cash value until you close out your first trade. From then on it is a combination of initial cash adjusted for any realised profit or loss.

Advantage:

Simple to calculate especially if you are trading a daily mark to market instrument. It is also the Float calculation method used by TradeSim (software used for electronic backtesting).

Disadvantage:

In comparison to method 3, you may experience:

1. More emotional highs and lows as all losses / profits are taken into account when you close;
2. In profitable streaks, you will take smaller position sizes (resulting in reduced $ profits); and
3. Conversely when in losing streaks take larger position sizes (resulting in larger $ losses).

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When do you calculate your float?

Having determined your Float calculation methodology, the next step to achieving greater consistency of returns is to determine, when this calculation should occur.

1. Prior to the opening of each new position?

Advantage:

Most accurate of the calculation methods.

Disadvantage:

If you have more than one position triggered on the same day, how do you order them? The first position traded will have the largest trade size, second position slightly less, so on and so forth until your last position which will be the smallest trade size. Obviously you don't want to have your largest position as a losing trade and your smallest position being the winning trade. Therefore, if you use this method for determining when you do your Float calculation you will need to determine a way of ranking your potential trades.

2. Once per day?

Advantage:

For a minimal reduction in accuracy and a slight increase in risk, this method answers the question on multi trade days of which trade ranks first. Answer…. They all do. All trades entered on the one day will have the exact same risk / trade size.

Disadvantage:

There is a slight reduction in both accuracy of calculation and a corresponding increase in the risk taken when using this method.

3. Other time frames (E.g. Weekly, Monthly, Quarterly, Semi-Annually, Never?)

Advantage:

The simplest method.

Disadvantage:

As the frequency of calculation diminishes, the proportional risk you take in each trade varies significantly. That is, when you experience a losing streak, as you are using the same risk / trade size for each new position, you are in fact taking larger and larger trade sizes compared to your float, leading to the unintended effect of increasing the proportional size of your losses.

For example say your initial float is $100,000 and your maximum loss percentage is 2% (or $2,000). If you experience a number of losing trades and your float reduces to $80,000, you could still be risking $2,000 per trade or 2.5% of your remaining float. To put it another way, when you are losing money you are increasing your risk.

The same scenario in reverse is played out when you start to make a profit (i.e. your float increases, yet your position sizing remains the same, resulting in the unintentional application of a handbrake to your profitability.

In the above example your initial float is $100,000 and your maximum loss percentage is 2% (or $2,000).If you experience a number of profitable trades and your float increases to $120,000, you could still be risking $2,000 per trade or 1.7% of your remaining float. To put it another way, when you are making money you are reducing your risk.

In summary, prior to commencing your live trading you should include in your trading plan:

1. How you are going to calculate your float; and
2. How often you are going to perform this calculation.

This will result in you having greater certainty in your position sizing and a large proportion of the emotional part of your trading evaporating.

If you would like to know more register here for HomeTrader’s FREE Intro Seminar.