Money management rules for stock trading
Money management rules are an obvious part of every good stock trading strategy.
These rules should answer these questions:
- How big is my risk for one trade ?
- How many opened trades I can have at a time ?
- What is my risk:reward ratio ?
- and other important issues
These money management rules will help you to identify how many shares you can buy or sell short in a particular trade.
How big is my risk for one trade ?
The definition of maximal risk value for one trade could vary a little bit. Generally, the numbers used are between 0.5% to 2% of the total account size.
The definition of maximal risk value for one trade could vary a little bit. Generally, the numbers used are between 0.5% to 2% of the total account size.
Example:
The account size is $100,000 USD. The maximum risk per trade is 1%. It means that you can risk $1000 USD on every trade. If distance between your entry and stop-loss level is $1 USD, then you know that you can open trade with 1000 shares. Simply calculated by (absolute risk)/ (point of distance between entry and stop-loss level).
The account size is $100,000 USD. The maximum risk per trade is 1%. It means that you can risk $1000 USD on every trade. If distance between your entry and stop-loss level is $1 USD, then you know that you can open trade with 1000 shares. Simply calculated by (absolute risk)/ (point of distance between entry and stop-loss level).
Should you open trade with 1000 shares? No! You must check other money management rules and combine the results.
My stock market trading tip:
If you are a beginner in trading, start with a small risk. Use 0.4% or 0.5% risk of the total account value. And as your confidence grows and your trading journal reports your success, increase it.
How many opened trades I can have at a time ?
It isn’t easy to manage trades by moving stop or taking profits manually if you have a lot of trades and only two hands! You must be able to manage trades manually in case of any strong move on the stock markets. Even if your trades are not day trades but you are swing trading on stock markets, it can happen. So every trader must limit the maximum number of opened trades. The absolute maximum for a single person is eight open trades at once. Don’t surpass this hard limit.
Five or six open trades at once as a maximum is an appropriate limit for every trader.
Example:
Your swing stock trading account size is $100,000 USD. You decided to have max. five open trades at once. Your broker provides you with a 2:1 overnight margin. That means you can use $40,000 USD for one trade. How was it calculated? 100,000 x 2/5 = $40,000. So when you plan to buy XYZ stock with a stock price of $20 USD, this rule tells you that you can buy max. 2000 shares. Combine it with the number of shares from the previous rule and use the LOWER value for your trade setup.
Your swing stock trading account size is $100,000 USD. You decided to have max. five open trades at once. Your broker provides you with a 2:1 overnight margin. That means you can use $40,000 USD for one trade. How was it calculated? 100,000 x 2/5 = $40,000. So when you plan to buy XYZ stock with a stock price of $20 USD, this rule tells you that you can buy max. 2000 shares. Combine it with the number of shares from the previous rule and use the LOWER value for your trade setup.
Special stock market trading tip:
During the first years of your trading set this number of trades to the lower value (like 3 or 4 max.)
What is my risk: reward ratio ?
Never, ever try to have the risk reward ratio less then 2.5 to 1. This rule is crucial in your trading statistics, especially if you’re new to trading and without any relevant trade history, so set this ratio to 3:1.
Other relevant issues
There are also other important rules, which are part of a stock trading strategy.
Trade only liquid stocks. stocks have an average daily trading volumeover 300,000 shares traded per day (for swing trading stock) or above 1,000,000 shares per day (for online day trading).
Trade stocks with a price above $5 USD. Stocks with a low price aren’t traded by big institutional traders and therefore are easily manipulated. Technical analysis can fail on such stocks. Also, most big investment funds don’t invest in such low-priced stocks.
All money management rules can be easily defined in spreadsheet (like Excel or OpenOffice Calc) and then all values are calculated automatically as you are entering your setup entry , stop-loss and targets .
Here is example of a spreadsheet table:
http://www.simple-stock-trading.com/moneymanagement.html
No comments:
Post a Comment