Thursday, December 21, 2006

Fundamentals of capital control

Work on financial markets is impossible without effective programs of funds investment. Effective capital management allows the trader to “survive” on the markets with marginal trade. Only observing equal proportion between profits and expenses, the trader gets a chance to work and not to play with money.

Let’s consider general principles and rules of capital management.

1. Total investment shouldn’t exceed 50% of total capital.

This principle prescribes the margin calculation rule for open positions: the size of the required reserve for using in non-standard situations and for normal work continuation shouldn’t be less than half of total capital. Murphy introduced this number (50%) but many analytics consider the percentage of invested capital to be 5% - 30%.

2. Total investment made in one market can’t exceed 10% - 15% of total capital.

In this case the trader is guaranteed against investing excessive funds into one deal that can lead to ruin.

3. Risk rate for each market receiving investment from the trader shouldn’t exceed 5% of his total capital.

Thus, if the deal turns out to be unprofitable, the trader is ready to lose no more than 5% of the total amount of his capital. The number “5%” is taken from Murphy’s work but, for example, Elder talks about 1,5% - 2%.

To be continued...

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