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Money Management in Trading our beloved stock market.

If you want to use the analogy of bets, you're making bets in the market.
As such, if you lose your chips you can't make any more bets can you?
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EFFECTIVE TRADE MANAGEMENT

 Either you know what you're doing or you don't. In trading you must know how to handle your money.

Face it... the more you know the better your decisions.

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 Today's "Trader Thoughts" FREE >>

   Rule number one, don't lose money.   Rule number two, don't forget rule number one.  However, since losses are inevitable...keep them small, use stop-loss orders.  I'll show you how to keep losses small in detail.

 Position sizing: more important than you realize. You have to minimize losses.

     As a rule, you don't want to be risking more than 2% to 5% max per trade. What that means is that if you have a $50,000 account, risking 2% per trade, than the most you can risk per trade is $1000 to $2500 at 5% max. You may want the ability to be in more than one or two trades simultaneously.

     Generally, you will never put more than 20% of the account value into any one trade. Let's say that out of that $50,000 we want to be able to do six trades: $50,000 divided by 6 equals $8,333 in any one trade of which we will not want to lose more than 2 to 5%. Now that we have our max risk and our total dollar amount per trade, we need to 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. Now we take our gross 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 than 1.6% of the account, which is even less then the 2% we are willing to risk.

This is a guideline to start a disciplined approach to trading.

Account Size:  $10,000

$25,000

$50,000

Per trade risk amount::      maximum   3%

Per trade risk amount::    maximum     3%

Per trade risk amount::   maximum  3%

3% of $10,000     =    300.00
This is your per trade risk.

3% of $25,000     =    750.00
This is your per trade risk.

3% of $50,000     =   1500.00
This is your per trade risk.

No more than 20% of account in any one trade = $2,000

No more than 20% of account in any one trade = $5,000

No more than 20% of account in any one trade = $10,000

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.

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

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

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.

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.

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 span
risk in the trade.

$150 is 1.5% of the account and less than the 3% we were willing to risk.

$300 is 1.2% of the account and less than the 3% we were willing to risk.

$600 is 1.2% of the account and less than the 3% we were willing to risk.

For options, you have different methods to choose from, remember itís 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 bought the stock AND I was willing to risk $150, $300 or $600 as a loss, wouldnít this allow me to give my option lots of leeway?  I donít have to be overly concerned if I follow this one rule:  if I wouldnít sell the stock based on the chart action, then Iím not going to get out of my option position even if itís down 40% in value.  Why?  Options are volatile due to leverage, but I already was prepared to lose the amount I paid for the option had I bought the stock.  I am in control.  I can always get out. 

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, youíll blow up your account.

     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.

Managing trades is a difficult job for all types of traders. Headline risk can make a profit become a loss.

You must take the time to appreciate the dynamics of the trading day and week- and events that drive the market- .

1. Manage open positions. There's a difference between a scalp trade, day trade, swing trade, position trade. You should know what you expect in price movement over what period of time... this will also tell you what you have to be on top of relative to market news. You can make things very sophisticated watching every tick or you can take long term positions... but KNOW WHERE YOU STAND.

2. Trade the chart you concluded was a good pattern. Use the 4 or 6 chart grid method following various time views...at a minimum use one time period above and one below the trade chart you started with.

3. Previous trend in relationship to your entry will tell you when to hold and when to exit.

4. Use a routine for the day and week and proper money management that will allow you to take advantage of events.

5. The trend is your friend no matter how much you tell yourself it's going to go the other way. Market conditions dictate price movement, not you.

6. Identify solid pullback in uptrends and rallies in downtrends to capitalize on previous trend. If your pick is going the opposite direction of the broad market but keeping it's previous trend intact that confirms a strong trend.

7. Generally, take no trades during the first 15 or 30 minutes unless you're trying to scalp a trade. Preferably, wait until the 10:30 reversal. Take no trades over the lunch hour leading in to the afternoon session. The last hour confirms trend, use it to enter or exit.

8. Choose a set of indicators you're comfortable with, and then leave them alone. There is no perfect indicator... indicators indicate, they do not dictate.

9. Use the Tick and Trin indicators during the day... avoid entering at extreme levels in the Tick as measure against recent day's extreme level.

10. Watch your trade relative to the broad markets. When a stock moves more sharply than an underlying index, it should continue to do so. 

11. Look for breakouts and breakdowns of the two-day range. Look for the 3, 4, or 5 days up or down patterns for a reversal to trend.

12. Know what you will do in the event of a huge quick move in your direction... the answer is generally take something, if not all, off the table.

13. You are not smarter than the market and you cannot wish it to move contrary to what you're seeing... learn to take a small loss so as to play another day.

14. Each trade stands on its own merits.

15. Appreciate what indicators are telling when you see divergence and what you'll do upon noticing divergence... this applies to all time views.

16. Stop concentrating on the money... focus on making a mistake-free trade with the odds in your favor, the money will follow. If you focus on the money, you're now trading with emotions... a costly mistake.

17. Add to position size when winning and reduce position size when losing... the first suggests the market itself is helping you out, the second suggest you may be fighting the trend of either the stock, the industry or the broad market.

18. There's nothing inherently wrong with being a contrarian as long as you are comfortable with the increased risk since your going counter trend.

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