A few weeks ago I wrote about managing risk for short-term traders. The topic dealt with what punters traded, and this week I want to take the “risk conversation” forward another step and talk about capital at risk per trade.
In other words, if you get into a trade and it goes against you, how much money would you lose, and what is that as a percentage of your portfolio? Ideally, you want the capital at risk per trade to be 1%, rising to 2% for experienced, profitable traders.
The first point is that before we can manage any of this risk, a trader needs to know their stop-loss level. This is the price at which the trader admits they were wrong and can exit the trade, no questions asked. Consider it a safety feature that keeps you in the game. Without a rigid stop loss in place before entry, that exit could be at a 100% loss … and more if trading in geared derivatives.
So, here’s the process. You find the trade you want to put on and decide on a stop loss. For me this is all about the chart; I am looking for a price that I really don’t believe will be hit in the next few weeks.
The next step is to decide at what price you are entering the trade. What are the costs to enter and exit, and what is the spread?
Let’s say my stop loss is R11 and I am entering the trade at R12. A 20c spread means I’ll actually enter at R12.20. When my stop loss triggers at R11, I will potentially exit at R10.80. So, the real world here is buying at R11.20 and stopping out at R10.80, losing 140c.
Then there are the fees. Let’s say 1% on either side adds another 22c, which makes my entire risk 162c.
Now that we know the real-world risk in the trade, the question is what quantity do I buy? Here we bring the 1% rule into play. We want to risk only 1% of our portfolio, so if my trading portfolio is R10,000, I am happy to risk R100 in a trade. Divide that 162c into the R100 and my quantity would be 61.7, which I would round down to 60 units.
At these numbers, if I am stopped out I lose R100 and my portfolio shrinks to R9,900. This is the point; losses are not a stress to the portfolio … just a bump in the road. If I just went all-in with my full R10,000 and got stopped out, I would lose almost 15% of the portfolio, and a few losing trades would halve it. A few more and it’s all gone. This rule is about staying in the game long enough to make a profit and not being wiped out by a few losing trades.
Let’s add a few more details. A minimum brokerage amount can throw all this out of the window. Say a minimum brokerage of R50 for buy and again for sell. That’s already R100, which is your 1%.
So, pick your platform carefully and, more importantly, always stick to your stop loss and position sizing.
