SIX TYPES OF RISK TO MANAGE IN TRADING
Trade risk.
The calculated risk you take on each individual trade is adjusted by changing your trade size. This is the only risk you can control. A good rule of thumb is to never risk more than 2 percent of the capital in your trading account on any one trade.
Market risk
.The inherent risk of being in the market is called market risk and we have absolutely no control over this type of risk.
Market risk may cause our carefully calculated trade risk to be much larger than anticipated.
Market risk can be far greater than trade risk.
For this reason it is best that you never trade with more than 10 percent of your net worth.
This type of risk encompasses catastrophic world events and market crashes that create complete paralysis in the markets.
Events causing market gaps in price against your trade are also considered to be market risk.
Margin risk.
This involves risk where you can lose more than the amount in your margined trading account. Because you are leveraged, you then owe the brokerage firm money if the trade goes against you.
Liquidity risk
If there are no buyers when you want to sell, you will experience the inconvenience of liquidity risk.
In addition to the inconvenience, this type of risk can b ecostly when the price is going straight down to zero and you are not able to get out.
Liquidity risk can be caused by or aggravated by a market risk event.
Overnight risk.
For swing/positional traders, overnight risk presents a concern in that what can happen overnight, when the markets are closed, can dramatically impact the value of their position. There is the potential to have a gap open at the opening bell where the price is miles away from where it closed the day before.
This gap possibility can negatively impact your account value.
Volatility risk.
A bumpy market may tend to stop you out of trades repeatedly, creating significant drawdown. Volatility risk occurs when your stop-loss exits are not in alignment with the market and are not able to breathe with current price fluctuations.
BASIC TYPE OF STOP-LOSS EXITS
1. Initial stop.
First stop set at the beginning of your trade.
This stop is identified before you enter the market.
The initial stop is also used to calculate your position size.
It is the largest loss you will take in the current trade
2. Trailing stop.
Develops as the market develops. This stop enables you to lock in profit as the market moves in your favor.
We exit the market when the market goes against us and our stop is hit.
3. Trend line stop.
Use a trend line placed under the lows in an uptrend or on top of the highs in a downtrend. You want to get out when prices close on the opposite side of the trend line
MOVING STOPS
Never move your stop for emotional reasons, especially when it is your initial stop .
As new trailing stops are determined, you can move your stops to lock in profit.
If you add on to your winning trade (increase your trade size), your stop must be adjusted to keep your risk in relation to your new trade size.
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RULES FOR OVER NIGHT TRADES
For daytraders, there is risk when holding trades overnight ,since there is always a possibility of unforeseen events occurring after hours. Unexpected events can create a gap open, which may adversely affect your account value.
For example, if you were trading a 15-minutetimeframe,your stoploss and position size would be based on the 15-minute time frame.
But, let’s say you are five minutes from the close of the day and the trade is profitable and much more profit is possible if you hold the trade overnight based on your 15-minute chart.
When this happens, consider five rules:
1. The trade must currently be profitable.
2. The 15-minute chart must indicate a solid trend in place.
3. You must set a new stop-loss exit based on the daily chart.
4. Reduce your trade size so that risk remains no more than 2 percent of your trading account based on the new adjusted stop from the daily chart.
5. Be sure to monitor the trade at the opening bell when the market opens the next day.
In this way you will take into account the inherent risks of holding the trade overnight. This will not eliminate your risk, but it will reduce it.
__________________
thanks,
regards,
Vijay k.
TWO PERCENT RISK FORMULA
As a starting point, It is recommended that you do not risk more than 2 percent on any one individual trade.
If you are a more advanced trader and choose to risk more than 2 percent, you will want to substitute the 2 percent amount in this formula with the percent you decide to have at risk prior to doing this calculation.
conservatively I have modified it to 1%.
Formula: Account size×1%=Risk amount
Example:
capital = rs 20,000
rs20,000×1%= 200
Remember,the risk amount of rs200 includes commission and slippage.
You will need to take that into account.
Now that you know what amount you will risk on your trade (rs200) you can figure out your proper trade size.
TRADE SIZE FORMULA
In the example, we can risk rs 200 per trade on a rs20,000 trading account.
The formula for determining proper trade size for this risk amount is as follows:
Formula: [Risk amount−Commission] ÷initial stop loss = trade size
Eg. ABC - ltp @ entry = rs 200 , initial stop = 198; i.e 2 rs , approx brok = 50
therefore [200−50] = 150 is the max loss amt if trade goes wrong.
No.of shares = 150 ÷ 2(initial stop) = 75 shares
we must also include the max loss per day. after crossing that we have to compulsorily stop trading for the day/
As an example, it can be set conservatively as 4% of capital.
that means after hitting 4 consecutive 1% loss, we have to stop trading for the day, and analyse what went wrong.
2 or 3 consecutive days of being stopped out means, for that week trading must be stopped.
__________________
thanks,
regards,
Vijay k.
Star is ready to shine..
it is purely based on ur risk tolerance, i.e eg. in 2 days u hit max stop for the week i.e 8% loss. it is worst case scenario
Instead of going for vacation, u would have paper traded the remaining week and analysed and found out whether the method worked for u or not.
If paper trade also showed loss means , that means something is seriously wrong with ur plan/strategy/psychology
u wont enter with real money next week Until u make a profits on paper trading or learn the basics once again.
If u can tolerate the high risk( not recommended), u can repeat the same strategy for next week. if again 8% loss means (total = 16%)
then stop trading for whole month and don't return with real money until u have improved.
the above are my personal risk mgmt. settings.
I would have followed the same.
__________________
thanks,
regards,
Vijay k.
just for clarification:
risk mgmt focusses on the steps necessary to minimize losses by assessing market conditions, risk reward, probability, placing of SL etc.
money management focusses on steps to maximize profits, by use of trailing stops, adding new position on break of pivots etc etc.
in short, "cut ur losses short(risk mgmt )and let ur profits run(money mgmt.)
__________________
thanks,
regards,
Vijay k.
