Money management based on a fixed ratio was introduced by Ryan Jones in his book The Trading Game: Playing by the Numbers to Make Millions.

The strategy works similarly to other money management methods in that your lot size will increase as your trading capital does.

Compared to the more well-known fixed fractional (or fixed risk) method, this one is a less heralded option for managing money. By using a predetermined percentage of your account balance on each trade, as in the fixed fractional method, you can limit your potential loss. The number of pips at stake in a deal serves as the basis for determining the appropriate lot size.

This is a good illustration of the use of fixed fractional money management. Imagine you have USD 10,000 in your trading account and you want to risk 1% of it by trading EUR/USD with a stop loss of 100 pips.

But how do you make trades if you don’t know how many pips you’re willing to lose? You might be employing indicator-based exits instead of a hard stop loss, for example.

Help is at hand in the form of fixed-ratio financial management.

**Fixed Ratio Money Management Calculations**

It can be difficult to determine how much account equity is needed for a given lot size. First, let’s establish some terms:

**Lot increment**

The percentage by which your lot sizes grow or shrink every time. Since foreign exchange is at play, we’ll work in increments of 0.01 lot.

**Delta**

The amount of money you need to make per lot before you can buy a bigger one. Your level of risk-taking in managing your finances is directly related to the delta. Your exposure to loss increases proportionally with the decreasing delta.

**Equity Step**

The sum of money you need to start seeing a profit again before expanding.

Equity Increment = (Total Number of Lot Increases Divided by (Delta))

Let’s use an example to better understand fixed ratio.

Let’s say you deposit $10,000 and decide to start trading 0.01 lots. A $2000 delta is used.

The equity stage in determining the amount of money needed to trade 0.02 lots (blue box) is as follows:

One lot increase multiplied by $2,000 is the equity stage.

Minimum Investment: $12000 ($10000 plus $2,000).

Similarly, if you’re now trading 0.07 lots but plan to increase to 0.08 lots in the near future (red box):

7 x $2,000 in stepped equity equals $14,000

Investment Capital = $14,000 plus $52,000, or $66,000

Even while the necessary equity step from the previous lot size grows with time, the delta value you choose will remain constant.

To get the dimensions of your lots, use the following formula:

**Which method of managing money, fixed ratio or fixed fractional, is better?**

Let’s apply these two money management strategies to a EURUSD trading strategy and evaluate their returns against their maximum drawdowns to find out.

### Baseline Trend Strategy

For this example, we will use a genetically developed M30 EURUSD trend following strategy from StrategyQuant. Both the moving average oscillator and the stochastic indicator are used as entry signals in this method. When it comes to managing risk, a 60-pip stop loss is useful. Lot sizes under the fixed fractional method will be calculated using this stop loss distance.

See how this approach fared with a $10,000 account and a fixed lot size of 0.1 below in a 17-yearback test.

Equity curves are ideal for evaluating the results of different investment strategies since they include both flat and rising portions. Profits and drawdowns will likely rise if we introduce money management.

### Fixed Fractional Money Management

Fixed fractional is one of the pre-set investment strategies available in AlgoWizard. This allows you to rapidly include it into your plan. The way you now handle your finances may be seen in the top right corner of the screen.

Click on the method to open the money management settings.

We’ll go ahead and set a fixed percentage of risk, or “Risk,” to our portfolio. Inputting the number of pips to risk per trade is unnecessary because the technique will automatically discover the 60-pip stop loss.

- Percentage of your trading account to use. Above a 3% interest rate is considered quite risky. Let’s play it safe and choose 1%.
- The number of digits after the decimal point in your lot size. Forex trading allows for increments as little as 0.01 lots, so we’ll go with that.
- If the fixed fractional computation fails, this ‘backup’ lot size will be used instead. The lowest value is 0.01.
- The maximum allowable lot size is of these dimensions. It supersedes the traditional method of calculating fractions. I’ll put in 5 lots for evaluation purposes. Since we are only willing to risk 1% of the account, we will never come close to it.

Now let’s redo the backtest!

The volume chart (blue) displays the growth of available lots over time. The original 0.16 lots were doubled to 0.32 lots, representing a 100% increase in the account’s size.

Above, you can see the results of a backtest. The ratio of return to drawdown has fallen from 4.74 to 4.09, despite the fact that both net profit and drawdown have gone up.

This is due to the fact that higher gross losses resulted from the strategy’s deep drawdowns only after the lot sizes had been greatly raised. On the other hand, the return/drawdown would have been higher if the strategy had seen its largest drawdowns towards the outset of the backtest.

Given the implementation of variable lot sizing, % Drawdown is more instructive than $ Drawdown.

Keep in mind the drawdown of 14.56 percent and the rebound of 4.09 percent. We shall evaluate fixed ratio money management based on these indicators.

### Fixed Ratio Money Management

The account’s balance will be zero when you first begin trading, so you’ll need to choose a lot size accordingly.

In keeping with the preceding fixed fractional method, we will use 0.16 lots as our initial investment.

Keep in mind that the level of assertiveness of the fixed ratio strategy can be adjusted by adjusting the delta value.

Adjusting the delta value to achieve a maximum drawdown of 14.56 percent during the backtest will enable a fair comparison with the fixed fractional strategy.

For example, after trying a $2000 differential and seeing just a 10% drawdown, I gradually lowered the delta to the levels shown below.

A drawdown of 14.85% can be expected from a $70 delta. Yes, that’s about right in my book.

I re-ran the historical analysis using a fixed money-management ratio and this delta value.

There is a striking resemblance between the fixed fraction and equity curves. Even though both earnings and drawdowns are larger than they were while trading at 0.16-lot increments, lot sizes have increased.

With this new method, the return/drawdown is 4.37, up from 4.09 with the fixed fractional method. Other performance indicators, such as profitability and expected value, are also slightly improved.

#### Why These Differences?

In the fixed ratio method, the only information needed to determine how many lots to trade was the total profit and the delta value of each trade.

I used the fixed ratio method to determine the percentage of my trading account I was putting at risk for each lot size.

The table below displays the average necessary equities between the present lot size and the next bigger lot size, denoted by the “Mid Point of Required Equity.”

Each trade’s risk is determined as follows: Lot Size * 60-pip stop loss * $10/pip.

It appears that, as the backtest progresses, you are gradually increasing the percentage of your account at danger. As the fraction decreases, the lot size can be increased past 0.33.

In the fixed fractional method, you risk one percent of your money on each trade.

The discrepancies can be attributed to the differential treatment of trade risk.

**Conclusion: Fixed-Ratio Investing vs. Fixed-Fraction Investing**

In this case, the fixed ratio technique was superior to the fixed fractional one. Does this prove that a set ratio is always preferable?

No!

Like any other strategy component, money management can be fine-tuned to meet the needs of a given backtest. Fixed ratio money management just so happened to do better in the aforementioned backtest for the specific sequence of trades.

In fact, the unequal treatment of trade risk inherent in the fixed ratio doesn’t appeal to me. Since you can’t predict when your strategy will fail, there’s no value in taking a bigger risk.

Risk is shared uniformly and the fixed fractional method is simpler to compute (and programme). That’s why it’s still popular after all these years.

Although I recognise fixed ratio as a possible substitute for fixed fractional, I cannot think of a scenario in which it would reliably surpass the latter. Fixed fractional money management is the simplest and more prudent choice if you are hesitant or new to trading.

In the section on developing trading strategies, I mentioned that my preferred method of money management was trading a certain number of lots for each dollar in account equity. For every $1000 in equity, I would allocate $100 to trading. It’s extremely similar to the fixed fractional method, with the exception that you don’t have to worry about the pips you’re risking on each individual trade.