Risking 1% of your total equity. Does this refer to the stop?

R

rogersmithiii

I'm taking a trading class at a local university, and I'm confused about a very basic point.

In class, we learned that position sizing is a major part of success in this business. The instructor suggested risking 1% of your equity on each trade as a beginning position sizing method.

Does this mean to set your stop so that any potential loss is that 1% figure, or does this mean to only spend 1% on any purchase?

For example, if I have $100,000 in my trading account, does this rule mean that I can only buy $1000 of stock on each trade? Or does it mean I can buy $100,000 of stock, but set my stop to limit losses to $1000?

On one hand, I know that prices can blow through stops, and give you a might larger loss than 1%. On the other hand, if this refers to total purchase size, if I was buying Chevron stock at $100 a share, I will only be able to afford 10 shares to stay within 1%. A $1.00 move in the price of the stock would only offer up a $10 profit. Considering my brokerage charges $9 in and $9 out, I'd be behind by $8.

Thanks
 
Position sizing would suggest no more than 1% of your equity toward each trade. $100,000 account would of course mean no more than a $1000 allocation toward any one trade.

I can't say I agree with that type of sizing unless the portfolio is quite large. Even that would tend to give you a lot of positions which in effect would track the indexes at some point. That losses the entire point of doing all that work to pick the stocks.
 
All of this stuff is totally arbitrary.

It's a figure someone sometime mentioned as a good benchmark for risk.... which IMO is wrong... It should depend on what your trade.

You should learn to understand risk, how to assess it and use several scenario's to give you some kind of VAR-analysis. So you know in each case what's likely to happen, and you're prepared for it... that's the most important thing in risk management.

If you trade stocks, you should understand that sometimes they do go bust... poof... And that sometimes gets more often, depending on what type of stocks. So you look at volatilities. Pharms move a lot more, and go bust a lot more often, than a bluechip. But also bluechips can go bankrupt.

If you trade index... say ETF's, they never really go bankrupt, since it's diversified. Same with futures, if you don't just use the amount of margin as trade capital, but use the underlying value instead.

If you trade options, especially short term, you have a lot higher risk. Using that 1% figure with options is just a silly thing to do.

If you want to use stops, it's better to think about when would you want to get out of a losing trade... and put it there. That way you actively think about prices and the how and why etc. Losses happen, be prepared for that, so don't put a stop 2 cents below your buy-price.

Also, risk and return go hand-in -hand. So if you only want to risk 1%... there's no way you'll be able to make 25%...

It's better to use your brain and think out a proper strategy with several scenarios.... and don't cut short the probability of a massive move, because those just happen...
 
The way I've always done position sizing and have seen and read in multiple places.

Account = 100,000$

I decide I want to enter a trade in a stock, I see my entry will be 100$, and I will put a stop at 90$ where I will exit if the trade doesn't go my way.

So that would be a 10$ loss per share.

One percent of my account would be 1000$. I'm only willing to lose 1000$ max on this trade. So I take 1000$ and divided it by the 10$ loss per share and come up with 100 which will be my position size.

I buy 100 shares at 100$ for a total investment of 10,000$.

The reason I use this method is I trade off charts and I always visually know where I want to get out(well below any possible daily noise). This also allows myself to take the volatility of the stock as just using basic percentages is not a great measure. A 5% move in a biotech may be a normal fluctuation while a 5% move in a big blue chip is a huge day.

Also take into consideration that stops are not guarantee and gaps through can happen , something to take into consideration especially in earnings season. You also don't have to hold it right to your stop. I have multiple rules for my strategies that include N amount of days stops, when to sell and maybe take half the loss expected and when to sell for half my expected profits.

The whole idea of any risk management strategy is to keep yourself in the game from perhaps one or two black swan trades. The winning percentage, average loss, average profit and many other metrics can be used to come up with the best position sizes for your strategy.
 
A ridiculous premise to have a fixed 1% loss--- likely taught by those who profit from your frequent trading. Please think for yourself!
 
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No one risks only 1 or 2% of their account on a trade.
That rule is for dumb people who have no idea what they are doing and are just gambling and playing safe odds o_O :confused:

I personally risk way more than that.

Keep in mind: those who can do ...Do -- those who can't...Teach.
If your teacher was a wiz trader, you think he'd be stuck in that classroom teaching you bozos...mumbo jumbo philosophical trading/investing theory nonsense...

I remember when I was in college...I showed my teacher the business finance newspaper of daily gainers...and asked him...How do I know or pick these...
And he replied: 'if i knew, I wouldn't be here' (sarcastically) ...he said it jokingly, but of course he also meant it.
 
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I would agree and also disagree with what JackRab has said above. Typically low volatility trades like ETF are not going to go bankrupt as he said and so can have more invested and higher volatility trades will have more chance of bankruptcy so you should put less money into the trades. However, I disagree that you can not make 25% without risking more than 1%. I have done it many times and I risk on average 0.75% per trade.

What you are failing to understand is that typically one needs to ADJUST their amount in a trade based on volatility of the instrument being traded. A stock like X (US Steel) for example and a stock like IBM would need to take these into account because X is much more volatile than IBM. So you need to measure VOLATILITY per stock by some measure or method. I tend to use a multiple of ATR (average true range) over some time period but there are others. Once you measure VOLATILITY you can now determine your stop loss point where you feel your trade would be WRONG. At that point you need to take into account ATR. Some people use an ATR multiple from entry price and others like me use a multiple from my proposed initial stop loss point. Then that becomes my REAL stop loss point. Now I subtract my REAL stop loss price from entry price. That difference then tells me how many shares I can buy. If that is $1 then I can buy 1000 shares. But my TOTAL risk is only $1000. Yes price can gap through and past my stop loss and I can lose more than my stop allows but these are rare and one of many reasons why I choose 0.75% risk.

Volatility determines how much of your account you can invest per trade because that volatility partly determines my REAL stop loss. The more volatile the stock the wider the stop....and the fewer shares I can buy. Sometimes I can have 70% of my account in a trade but only risk 0.75%. Other times I may have 5% of my account in a trade but still risk 0.75%. Lastly, the LATER you enter a trade from your stop the further your entry price will be away from the stop and obviously the wider your stop so the fewer shares you buy.

Also the reason for the 1% rule is because of downside protection when you have multiple losses especially on a losing streak. If you are down 10 trades in a row you are at $90k when risking 1%. To get back to even you need to make 11%. (Not too bad). When you risk 2% let's say then you have $80k and need to now male back 25% just to break even. That is harder than it sounds. So the 1% rule is for drawdown protection. Volatility rule is for per trade stop loss risk management and determining position sizing for THAT individual trade.

I hope this helps. Good luck in learning. It never stops.

Eganon
 
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lawrence-lugar said:
No one risks only 1 or 2% of their account on a trade.
That rule is for dumb people who have no idea what they are doing and are just gambling and playing safe odds o_O :confused:

I personally risk way more than that.

Keep in mind: those who can do ...Do -- those who can't...Teach.
If your teacher was a wiz trader, you think he'd be stuck in that classroom teaching you bozos...mumbo jumbo philosophical trading/investing theory nonsense...

I remember when I was in college...I showed my teacher the business finance newspaper of daily gainers...and asked him...How do I know or pick these...
And he replied: 'if i knew, I wouldn't be here' (sarcastically) ...he said it jokingly, but of course he also meant it.
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I agree and have been risking in excess of 5% of my account on each trade lately although I do have some risk of ruin concerns floating through my head.
 
rogersmithiii said:
I'm taking a trading class at a local university, and I'm confused about a very basic point.

In class, we learned that position sizing is a major part of success in this business. The instructor suggested risking 1% of your equity on each trade as a beginning position sizing method.

Does this mean to set your stop so that any potential loss is that 1% figure, or does this mean to only spend 1% on any purchase?

For example, if I have $100,000 in my trading account, does this rule mean that I can only buy $1000 of stock on each trade? Or does it mean I can buy $100,000 of stock, but set my stop to limit losses to $1000?

On one hand, I know that prices can blow through stops, and give you a might larger loss than 1%. On the other hand, if this refers to total purchase size, if I was buying Chevron stock at $100 a share, I will only be able to afford 10 shares to stay within 1%. A $1.00 move in the price of the stock would only offer up a $10 profit. Considering my brokerage charges $9 in and $9 out, I'd be behind by $8.

Thanks
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You have been on ET 7 years, how is it that you are asking this question now?
 
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