Continuing the animal theme (despite failing to catch the dead bouncing cat)or in this case fish I have been studying the three Ms of Trading Mind, Method and Money. Mind being the psychology of trading, method how you trade and Money being the management of your money. Today I have been concentrating on the Money which I consider the most important after all the reason to do this is to make money (even if it is the most exciting thing to do with your clothes on!) and you can't make money if you don't have any money to trade with so if you lose all your initial investment, unless you have deep pockets (which I don't) you are sunk.
To save yourself from the sharks you should only risk a maximum of 2% of your total capital on any one trade preferably less because of commission, stamp duty and other costs so if my investment is £10,000 I should only risk £200 that doesn't mean I can only buy shares up to the value of £200 in any one share because with the expenses I would never make any money BUT when I buy a share I must also set a selling price known as Stop Loss and if the shares hit the Stop Loss they will be sold and I will have limited my losses and it is the margin between my buy price and my stop loss which is my risk and which in this case must not be more than £200.
To save yourself from piranhas in any one month your risk at any one time must not be more than 6%. Stop Losses can only be moved in the direction of a trade and so if you are trading shares to go up the stop loss can be put up as the share price rises and once your stop loss goes over your buy price your risk is gone and therefore you can place that risk on other trades but can never be put down. If your stop losses are activated and you lose 6% in any one month then you must stop trading that month and close any open risk trades.
The 2% and 6% are calculated once a month on the total value of all open trades or cash in your account and so if you are doing well the amount of money you can risk will go up but if you are doing badly it will go down and the 6% rule stops a losing streak and makes you re evaluate what you are doing.
This will take a lot of discipline because if you are at your 6% limit then you can't open any more trades until your risk decreases however tempting a particular share might seem - but it will save you from losing your shirt.
Lots to think about.
I like that recalculation of the percentage, thats a really good idea.
ReplyDeleteAnd a trailing stop will hopefully become our friend (as you say, changing a stop in the direction of the trade.
I do wonder about adding to a trade in the right direction so that it goes *over* the 6%, but it would have to be with a really, really tight stop. Hmmm.