This is one of the most difficult things in trading.
It almost seems counter intuitive. The only way you can ever hope to be a success is to control your risk.
If you are reckless and blow up your account you will run slap bang into the one reality – if you have no money you cannot play. The trick in trading is to preserve your capital so you survive long enough and are able to take that trade that will come along and will make all the difference to your account.
I’m going to talk about stops in another article and how to set them however let’s consider this scenario briefly now.
Let’s say the amount of money I have in my account is $20,000.
How much of my account am I prepared to lose on a trade. For some people it might be 1% ($200) for someone else it might be 2% ($400). Sounds good right? However, it is actually statistically possible to have a run of losses over 20 losses in a row so at a 2% risk, you could have an $8,000 draw-down or more. (Not only COULD this happen to you, if you trade long enough it WILL happen to you)
To continue our example, if a share is priced at $40 per share and you are prepared to risk $400 on the trade, how many shares do you buy? Well is you are prepared to lose 10% of your money it’s easy to calculate.
$40 – 10% is $4 so $4 per share. Risking $400, you can therefore buy 100 shares ($400/$4).
A great book to read about risk is Nick Radge’s excellent Adaptive Analysis (Amazon Kindle eBook click on cover below) or Van Tharp’s Trade your way to Financial Freedom (Click on cover for Amazon link).
Click link below for The Book Depository
Book Depository Link
Originally posted 2017-05-01 18:31:50.