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# Understanding Risk and Money Management

Discussion in 'Risk Management' started by jlcarey1, May 1, 2007.

1. ### jlcarey1

I would like to start a discussion on risk and money management. These topics are probably the most important ones for a trader or investor, but are not talked about too much.

Current price: 52.80
stop price: 52.15
potential target: 55.00

Subtract stop price from current price: .65 = RISK
Subtract current price from target: 2.20 reward
Divide reward by risk, 2.2/.65= 3.38 = Risk/Reward Ratio. I like to take ratios that are higher than 1.6

Now, we need to calculate how many shares I can afford to trade based upon a 2% account risk. Meaning that I cannot lose more than 2% of my total account on any one trade. So, given the account size of \$50,000, 2% of that equals \$1000.00. So, I cannot lose more than \$1000 on this trade given my current account balance. So, if we divide the Max Loss Amount by the Risk Amount, \$1000/.65= 1538 max shares we can buy.

Now comes the tricky part. Obviously, one would not buy an odd lot number of shares like 1538, so I will always round down to the nearest logical number which in this case is 1500 shares. I don't know what to do next. If I purchase the whole 1500 shares, then I am sticking with my previously calculated Risk/Reward numbers. However, if I scale into the trade and purchase half my total shares first and then wait for some confirmation that the trade is going in the right direction and then purchase the remaining half, I have now (somewhat) screwed up all of the calculations I just did because my average cost on the stock will now be different and the risk is now something other than the calculated .65 cents. In other words, if the trade is a long purchase and I have scaled into the trade, my average cost will now be higher and my risk is now bigger.

So, the discussion picks up from there. Do you think this strategy is good or does it suck? What do you use? Is 2% too much? Should go down to 1%? How do you enter your trades? All in or scale into it?

The other question I have is how do you measure a potential target for a stock? How do you determine where it might go? Please tell me your experiences.

Thanks.

lol

3. ### rcanfiel

I would like to start a discussion on risk and money management. These topics are probably the most important ones for a trader or investor, but are not talked about too much.

<b>I disagree. The most important thing is finding a method that OUTPERFORMS. I consider those who say "I can use random entries & exits and make big money by money management" as incompetent traders. It sounds good and everyone "knows someone who does it regularly", but proof is always hard to find</b>

Now, we need to calculate how many shares I can afford to trade based upon a 2% account risk. Meaning that I cannot lose more than 2% of my total account on any one trade. So, given the account size of \$50,000, 2% of that equals \$1000.00. So, I cannot lose more than \$1000 on this trade given my current account balance. So, if we divide the Max Loss Amount by the Risk Amount, \$1000/.65= 1538 max shares we can buy.