The difference between the entry price and the stop loss is my maximum loss per unit. Function of my risk tolerance and my trading method I decided on a percentage of my account I'm willing to risk on each of my positions, i.e. 2%. If my current account value is $50k, I risk at most $1k per position. Dividing the maximum loss per unit into the $1k, determines the size of my position.
It appears that this is a combination then of both charts and account balance analysis. This may be the proper approach using both. I wonder if there are others that use a combination or just one of the two--Best regards
Hey Buy1Sell2, you asked about stops in the emini thread as well, but I think I see here that you might actually be looking for some clarity on the larger stop placement/money management/position sizing issue, and how they relate to each other. Let me summarize the way I look at it, and then run through an example. 1 - The amount you are willing to risk per trade should not determine your stop, it should instead be set by evaluating the chart (or by using some other system criteria) 2 - Instead, the amount you are willing to risk per trade should actually determine your position size, considering the given stop you have set. 3 - The amount you are willing to risk per trade should be based on the system you are using...and if you are a new trader, it should be set really low to allow for many mistakes and drawdowns without running through your capital. Here is an example: First, determine what percentage of your account you want to risk on each of your trades. For the sake of things here, lets say a quarter of one percent, so that you can make some mistakes or absorb some drawdowns and stay alive a while. Then, lets say your account balance is $40k. So, 40,000 x .0025 = 100. For this exercise, you will try not to risk more than $100 on any given trade. Cool. Now, lets say you are looking to trade stock XYZQ. Lets also say that your analysis of the XYZQ chart suggests that if after you enter the trade at your desired price, if the stock moves against you .50, than the reason to be in the trade is no longer valid. In other words, if the price gets to that point you know the set up has failed, and you will get out. So that is where you will place your stop, you are willing to risk .50 of movement on this trade. So, at this point you know your stop is .50 of movement. And you know you don't want to risk more than $100. You can determine that you can buy 200 shares to meet your predetermined risk limit. Now, I would suggest that if you can set stops off the chart analysis as we did above, that is the way to go. But lots of people do it other ways, as have I on occasion. Regardless of what you use to determine where to put the stop, the logic to determine postion size is basically the same, as long as you know the price movement you want to risk from your stop. So lets say you decide to set stop by percentage of share price. Maybe in your system you set a profit target at 1.0% of the share price and set a stop at 1.0%. So lets say the shares of the stock are selling at $25.00. In the above model you are willing to risk .25 price movement against you before you bail the trade. In order to stay within your $100 risk parameter, you can buy 400 shares. Whew, does that make any sense, and is that what you were looking for? Hope it helps, Dodger
I think this is what you guys were talking about in an easy excel format. Put in account total, risk per trade in percentage, then stick your buy price in there, choose your stop loss based on the charts, input numbers and buy the shares for your maximum risk per trade.
In that case it is another risk management tool : model and operative risk. It lets me know (mail/phone/SMS) when a certain limit of losses is reached (typically something like a loss of 10-15%, and it blocks everything at something like a loss of 20-30%. Of course these numbers depend on volatility. Reaching such losses just means something went wrong with the systems themselves.
Art, thanks for your post I certainly think that the points are extremely valid. By having a position too large to make sense chartwise etc., a trader would be putting themselves in an almost no win situation. I am reasonably sure that this is the most important aspect of trading as opposed to outright directional analysis. This would seem to let you be wrong and still wind up a winner over all. All new traders should probably have this tattoed on the back of their wrists so they can see it when hitting the buy button on the online account. What say you?