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Risk
Management
Research for Online Investors
This orginally appeared in MarketToday on 4/21/10
If
you trade stocks, you know how frustrating it can be. I read an article yesterday that the biggest
challenge to traders is confidence. Not the kind of confidence that allows you to place a trade for thousands of
dollars. Many of us can do
that. The kind of confidence
that can hurt you as a trader is if you cannot admit a mistake. You have to accept defeat to control
the risk in any stock trade.
If
you are trading, you are making mistakes. How tough is trading? 80% of fund
managers don’t beat the major indices! That
means if you bought the SPY and went on vacation for a year, you would beat 80% of the mutual fund
managers!
Many
traders are wrong more than they are right. The key is money management. Don’t risk
too much on any trade, and let your winners run. No
matter how confident you are in a trade, don’t risk anymore on it than any other. Many
professional money managers won’t risk more than 2% or 3% of their total capital on one
trade. Some may go as high as 5%, but that is a
tremendous risk. A loss takes a lot of your money off the
table.
Today
let’s use 3% as our limit to lose on any one trade. Does
that mean that you only put 3% of your total funds into any one trade? No. When entering, what percentage amount are you
willing to let the trade go against you before you sell and go to your next trade? Let’s
say you have a nice setup with a downside risk of 5%. If
the trade goes down 5% from your entry price, you will sell and never look
back.
If
you have a $100,000 portfolio, your absolute maximum risk on one trade would be $3000
(3%). Now you see why 3% is, and should be, on the
high side of the risk you are willing to take on any one trade. If we
look at the trade you want to enter, and your entry price is $30, and your stop loss is $28.50 or
5%. You are willing to lose $1.50 per share if the trade goes against
you.
Your
maximum loss is $3000, so we divide it by $1.50 which tells us we can buy 2000 shares. Our maximum
total outlay on this trade is 2000 shares times the purchase price of $30 equals
$60,000
I
never enter a trade that large as a percentage of capital, or risk 3% of my capital. Why? Because I would rather have multiple trades working,
because I KNOW SOME ARE GOING TO LOSE MONEY.
Pardon me if I don’t exude confidence, but experience has made me very
humble. The other challenge to you as a trader is
talking about your trades. Have you ever heard people talking about how
good a trade they made? This is dangerous ground. When
you talk about a trade, you psychologically become ‘married’ to it. You
have placed personal pride in the outcome. This makes it harder to accept a loss and move
on.
So,
repeat after me….I will never discuss my trades with anyone. There is one exception to this
rule. You can tell people
about galtstock.com!
The information presented in this newsletter is based on generally available news releases, corporate filings,
current events, interviews and the editor’s opinions. It may contain errors and you should not make investment
decisions based solely on what you believe you have read here. Do your own research, it is your money. If you lose
it, it is your responsibility, not ours or your grandmothers! The editor may or may not have a position in any
securities discussed. The editor may have held a position in a security earlier, or in the
future.
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