Risk Per Trade in Macro Investing

I have read a few books (and online resources) on macro investing but I still don't have a good grasp on the concept of risk per trade. Could you help me understanding it please? (below are a few thoughts I have on this).

I find the consensus advice from the legends and pros is that that traders should not risk more than 1-2% per trade. However, I am not sure what exactly this number means. I have thought and interpreted this in a few ways:

1) Based on AUM: For instance, if you manage $100 mm, then your gross exposure per trade is $2 mm. Says if you make 10% on that trade then you make $200 m. You will need 100 profitable trades like this to make 20% return pa. I think 100 10% profitable trades per years is not feasible (let alone 100% batting average).

2) Based on required margin to maintain the trade: If you put on an S&P 500 trade, with 2% risk, you can buy 476 ESU7 contract (total exposure of ~$57.5 mm) for a total required margin of ~$2 mm. If the trade goes 5% in the opposite direction, you would lose ~2.9%.

3) Based on some a combination of trade time frame and volatility. For instance, if you put on a short-term trade, says a week, and the median volatility of that security is 6% weekly, you put on a trade size so that at 6% move in the opposite direction, you would lose 2% of your AUM and you are out of the trade. (side note: I calculated a few examples using 2) and 3) and find the total trade exposure are within a reasonable range, could it be the margin requirements take into account of volatility!?).

Thanks gents and happy the Fourth of July!

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Comments (4)

Jul 5, 2017 - 5:08am

Risk is usually defined by maximum loss not just exposure. For example, if you have a position that is 10% of assets but you set a hard stop at 20% move against you, your risk for that trade is only 2% (provided sufficient consideration for liquidity so you can actually get out at your stop).

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Aug 17, 2018 - 10:55pm

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