Take this as an unbreakable rule in risk management: An EA cannot ignore the percentage of the balance allocated in each trade. Let's see how it works and whether this is sufficient in all cases.
Relationship between Stop-Loss, Risk, and Position Size
Adequate risk management is essential in trading. Moreover, it is unforgivable not to implement such management in algorithmic trading, given the available computing power. An EA needs to know the stop-loss in advance to implement risk management, since it determines the magnitude of the adverse movement that can be tolerated. In this way, it is possible to calculate the necessary position size so that, if the stop-loss is triggered, the loss remains within the predefined percentage. However, not all EAs take risk management seriously.
Configuration Scenarios in EAs
- Using only a fixed "volume" parameter:
Some EAs operate with a constant size. In this case, the variability of the stop-loss causes the risk in each trade to fluctuate. If the stop-loss is set very tight, a larger proportion of the balance is risked; if it is set wider, the risk decreases. This generates inconsistency in capital exposure. - Defining risk as a percentage of the balance:
This strategy ensures that the same fraction of the balance is risked in each trade, but it produces position sizes that vary significantly depending on the proximity of the stop-loss. A very tight stop-loss can result in an excessively high "volume" value, while a wider one will notably reduce the position size.
Among the two scenarios above, only the second one properly manages the risk of your trades. It may be unsettling when your position size becomes enormous, or discouraging when it becomes minuscule; but if you have properly backtested and your psychology holds up, it is the way to avoid catastrophic losses.
How? Would you like to know if both approaches can be combined? Let’s see...
The Solution from Scout The Smart Hunter
The expert advisor Scout The Smart Hunter integrates both key parameters:
- Risk Limit: Defines the percentage of the balance to be risked in each trade.
- Maximum Volume: Sets an upper limit for the size, so that even if the calculation based on the stop-loss suggests a high "volume", it is capped at the maximum allowed value.
This combination ensures that, regardless of variations in the stop-loss distance, the risk remains constant and the position size stays within reasonable parameters. For example, if the ideal calculation based on risk exceeds the maximum allowed, the EA will adjust the size to that threshold.
System Benefits
- Constant Risk: Each trade risks a maximum percentage of the balance, regardless of the stop-loss conditions.
- Exposure Control: Integrating a size limit prevents the EA from assigning disproportionate volumes in situations with tight stop-losses.
- Operational Adaptability: The system dynamically adjusts to different strategies and trader psychologies, offering coherent risk management and enhancing the discipline of the algorithmic trader.
Conclusions
Integrating the calculation of position size with a control based on a percentage of the balance and an upper limit improves operability while remaining consistent and secure. Scout The Smart Hunter is an example of this methodology. Download the demo to experience the combination of these parameters and their effect on efficient and adaptable risk management.
