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EFFECTIVE TRADE MANAGEMENT
Money
Management: Just a little important, don't you
think!!
Rule number one, don't
lose money.
Rule number two, don't forget rule number one.
However, losses are inevitable...keep them small, use
stop-loss
orders.
Position
sizing:
As a general rule you don't want to be risking more then 2% a
trade and 5% max and you want to have the ability to have
multiple trades on at once. What that means is that if you have
a $50,000 account risking 2% a trade then the most you can risk
per trade is $1000. You want the ability to be in more then one
trade & you need to pick a good number of potential trades to be
in. In the example we have $50,000 so let’s break it into 6
sections. 50K divided by 6 is $8,333.
Now that we have our max risk and our total dollar amount per
trade we need to go find a trade. In this example we have a
stock trading at $20 with an objective at $26 and a stop at $18
giving us a 3 to 1 risk reward ratio.
So now we take our dollar amount per trade (8,333) divided by
the price of the stock. This equals 416 so we round down to 400
shares. Now take the distance from entry to stop ($2.00) and
multiply it by 400 now we get $800.00. That is our risk in this
trade so we are risking less then 1.6% of the account which is
even less then the 2% we are willing to risk.
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Keep this in mind- it’s your money.
This is a guideline to start a
disciplined approach with, so let’s plug in some
numbers:
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Account
Size:
$10,000
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$25,000
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$50,000
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Per trade risk
amount::
3%
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Per trade risk
amount::
3%
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Per trade risk
amount::
3%
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3% of $10,000
=
300.00
This is your per trade risk.
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3% of $25,000
=
750.00
This is your per trade risk.
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3% of $50,000
=
1500.00
This is your per trade risk.
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No more than 20% of account in any one trade = $2,000
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No more than 20% of account in any one trade = $5,000
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No more than 20% of account in any one trade = $10,000
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Divide the $2,000 by the stock price, say $23.50 per
share; this equals the # of shares you would get and
round that number up or down.
In this case, it equals 85 shares rounded up to
100 shares.
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Divide the $5,000 by the stock price, say $23.50 per
share; this equals the # of shares you would get and
round that number up or down.
In this case, it equals 212 shares rounded down
to 200 shares
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Divide the $10,000 by the stock price, say $23.50 per
share; this equals the # of shares you would get and
round that number up or down.
In this case, it equals 425 shares rounded down
to 400 shares
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Calculate the difference between your entry price,
$23.50 to your stop loss price,
say $22.00, which is $1.50.
That $1.50 times the # shares you have, 100,
equals $150.
$150 is your risk in the
trade.
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Calculate the difference between your entry price,
$23.50 to your stop loss price,
say $22.00, which is $1.50.
That $1.50 times the # shares you have, 200,
equals $300.
$300 is your risk in the
trade.
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Calculate the difference between your entry price,
$23.50 to your stop loss price,
say $22.00, which is $1.50.
That $1.50 times the # shares you have, 400,
equals $600.
$600 is your risk in the
trade.
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$150 is 1.5% of the account and less than the 3% we were
willing to risk.
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$300 is 1.2% of the account and less than the 3% we were
willing to risk.
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$600 is 1.2% of the account and less than the 3% we were
willing to risk.
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For options, you have different methods to
choose from, remember it’s a choice, your money,
your choice:
I can put in the same $2,000, $5,000 or $10,000
in an option trade and calculate my risk amount
by the above calculations where the $150, $300
or $600 will be the amount I might pay for an
option contract on that stock until
it totals my 3%.
However, here is where you have to think this
through... If I was
buying the stock AND I was willing to risk $150,
$300 or $600 as a loss, wouldn’t this allow me
to give my option lots of leeway?
I don’t have to be overly concerned if I
follow this one rule:
if I
wouldn’t sell the stock based on the chart
action, then I’m not going to get out of my
option position even if it’s down 40% in
value.
40% of $150, $300, or $600 is $60, $120,
and $240 respectively.
Alternatively, I can and probably should,
consider not 20% of the account value in any one
option trade, but only the amount that I was
willing to risk HAD I BOUGHT THE STOCK.
In this example, my total option trade
would be $150, $300, or $600.
Or any number in between where you can
sleep at night if it gapped up/down against you
in a big way.
The above are not rules set in stone except for
the "per trade risk amount".
The rules are a starting point for
a disciplined approach to trading.
If you start playing with options like a
gunslinger, you’ll blow up your account.
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Using position sizing enables us to
manage risk. By dividing our account up into multiple trades no
one stock can kill us in the chance that a surprise event
happens such as earnings preannouncement or geo-political event.
And then by only risking a certain percentage we cut risk even
more.
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