You mean you dont have an idea to the potential drawdown of your system method?
Then you need to do some research, backtesting, and paper trading for at least several months to find out!
You mean you dont even have a method or system?
Then you need to do alot of reading, research, testing, experimenting, and paper trading to develop / learn a method.
Why is having a method or system important?
A method or system allows you to trade with a plan. A plan where you know the potential risks and reward. Where you try to exploit some kind of edge or perception for profit. A plan outlines what you need to do.
Trading is no different than running a business. Like a business, a trader needs to have goals and objectives, good knowledge of the craft and markets, a detailed set of operating procedures, etc. Then consistency and discipline must be applied to adhering to the business plan.
A trading plan should clarify the approach to be taken. Will you be position trading for long term moves? Will you be trading in the direction of the primary trend? Will you be short term / swing trading off of support and resistance? Etc.
A trading plan or approach should have a clearly defined set of guidelines to how you are going to trade.
What are the indicators or analytical methods to be used to determine a directional bias? Only a good deal of research will allow you to select a method(s) that have proven reliable over a long period of time under different market conditions.
What are the entry strategies to be used? What is the level of risk for your trades? Where will you get out if you are wrong? Where will you exit? How are you to manage the trade?
As you can see – planning and organization are important to successful traders. All successful traders have some sort of methodology, system, and trading plan that they adher to. It is important to take the time to do this… otherwise it becomes impossible to be disciplined and consistent in your trading. Lack of planning leads to impulsive, emotion driven trading.
Without a clearly defined plan, it is next to impossible to make objective trading decisions. To make it in trading, one needs to be highly disciplined and consistent in their approach. The trading plan allows on to be disciplined and highly focused.
Capital preservation, identifying and reducing risk are also very important and should be spelled out in a methodology or plan. Every trade should have a level of risk that is comfortable to the individual, and that does not put the account in danger in the case of several losing trades. Hoping and praying for a market to move in your direction is a losers game.
A trader analyzes a market and makes his forecast ( all traders forecast, whether they are aware of it or not). A directional bias or possible reversal is identified, and a trade is taken using some form of entry strategy. At what point does the market invalidate your bias or forecast? Where and how will you limit your risk? If wrong, how much of your total capital will be lost?
These are some thoughts… things that should be considered when trying to determine how much capital to start with, and how to identify potential drawdown. Much research and thought should be taken in order to have a realistic idea of how to start.
For continuation, see part three of this rather long original article.