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

[dealmaker]

Could be the more time spent reading some of the posts here, the less you know.

I am curious what his response will be....

 

[ironchef]

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.

That is why if one follows the advice: Trade small and trade often, a small retail trader will blow up his account eventually but his broker will get rich.

 

[Handle123]

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

I as well risk less 0.75 %, but one has to define you one's own rules that define risk, most on forum who still use archaic measures to define risk will see it as they used what is in books or whatever they deem fit for their back testing. You can only back test so much and trading forward can seldom show enough viable sample size to know for sure it you are on right direction of being ultimately right in one's desired path.

 

[trickshot]

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?

I'm going to say that your instructor meant the former. Its impossible to only spend 1% on a purchase unless you started off with a huge account. Risking 0.5 - 1% on a trade is pretty standard risk management, btw its definitely possible to risk 1% to make 3 - 5%, just don't expect a 90% win rate to go with that.

 

[Zzzz1]

You seem to be the first one in this thread to "get it". Nice walkthrough for beginners. While nothing in trading is set in stone many overleveraged people who are a stone throw away from bankruptcy would be advised to at least follow an approach such as the one you described.

It's amazing how some people on this board (I even saw a self proclaimed previous professional) think the 1% sizing "rule" pertains to a position size of 1% of the account and then moan how such approach does not make sense.

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.

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.

 

[Zzzz1]

A lot less ridiculous than frequently putting at risk 10 or 20 or 100% of the account balance. The correct approach as described by @Metamega makes a lot of sense actually. It is not the absolute percentage amount that is key here (choose whatever amount you are comfortable with) but the process.

A ridiculous premise to have a fixed 1% loss--- likely taught by those who profit from your frequent trading. Please think for yourself!

 

[Zzzz1]

.... Sure, if you trade with a broker that charges 9 bucks for 10 shares as OP stated.

That is why if one follows the advice: Trade small and trade often, a small retail trader will blow up his account eventually but his broker will get rich.

 

[globalarbtrader]

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

Stop. Because you should set your stop depending on the risk of what you're trading.

GAT

 

[Simples]

Do yourself a favour and study risk of ruin in trading. Typically the general newbie advice of 1-3% of risk until stopped out prevents most blowups, but not death of thousand cuts. Only meaningful on large accounts in relation to total equity. It's boring but the largest traders try to risk much less than 1% of total account! But depend on overall rules, so possible to risk more on some type of trades. When you can avoid ruin you can start improving overall performance.

Of course you risk much more if stops don't work so no silver bullet.

 

[Zzzz1]

Agree and may I add couple additional points:

* Without edge one blows up sooner or later, regardless of risk, taken. Edge has to come first, before any risk management considerations. Many market practitioners on the retail side state that risk-management in itself is an edge, and the ability for retail traders to sit on the sidelines and/or size positions as function of opportunities quickly (faster than professionals) is an edge. Well it is but that is an edge only if the underlying mechanics of the trade has an edge. Without an edge that produces statistically profitable aggregate trades it does not matter whether one risks 0.5% or 10% off account balance on each trade.

* One has to decide why one is in the market. For the excitement or to make money. To ensure survival over a long period of time may I suggest trading can be very boring. I enjoy the process of discovering new ideas and testing ideas and implementing them a lot more than the actual trading process. So much more in fact that I automated most of my strategies and let computers decide how and when to trade. If one is in this for the excitement then one will necessarily have to trade larger than prudent position size. While that delivers more excitement to some (to me it gives me the shivers), it also highly inflates risk of ruin. One has to come to terms with what one wants to get out of the markets as Ed Seykota put it so succinctly.

Do yourself a favour and study risk of ruin in trading. Typically the general newbie advice of 1-3% of risk until stopped out prevents most blowups, but not death of thousand cuts. Only meaningful on large accounts in relation to total equity. It's boring but the largest traders try to risk much less than 1% of total account! But depend on overall rules, so possible to risk more on some type of trades. When you can avoid ruin you can start improving overall performance.

Of course you risk much more if stops don't work so no silver bullet.