Risk Management for Stock Market : Here are the expert advice on how to choose right position size for your trading but before that you need to understand the basics of position sizing and prerequisites for it.
What is Position Sizing?
It refers to the size of the position in a particular portfolio. It is the number of shares (lot) per trade or the amount that a trader will be investing per trade.
The biggest question in every trader mind is how big should be his position for any of the trade.
Importance of Position Sizing
- To prevent a draw-down with substantial amount of capital on single trade.
E.g: Mr. Hiren has Rs. 2, 00,000 as trading capital. He feels confident about that script LMN is currently priced at Rs. 100 and thinks that price will go higher in next few days. Hence he buys 750 shares of LMN. On the next day he hear that famous products of the company are banned in UK and other countries and the price open 22% below as compared to the entry price. Due to this unforeseen condition Mr. Hiren decided to exit the trade. In other words, he sold all his 750 shares at Rs 78 and reduced his trading capital to Rs 58,500 in a single trade! So, his single trade capital loss = 29.25%
Prerequisites before Position Sizing
Generally common traders take trades based on the expert advice, friend’s suggestion, any news channel influence etc. They don’t have a constant and concrete approach to take their trades.
- Must have Trading System: You can use any indicator to get additional confirmation. It can be anything like Moving Average crossover, Bollinger Band Expansion, Divergence, Trend like breakout etc.
- Observe Behavior: once you have trading system start observing behavior in uptrend, downtrend, sideways, random by checking its behavior with past data.
- Have constant time frame: every indicator behave differently so use based on its performance.
- Practice Paper Trade: it is nothing but simple process to write all the values like entry price, entry date, SL, Profit target etc.
How to calculate position Sizing?
You should always know how much you are ready to lose per trade if something goes against you. A thumb rule states that one should not risk more than 2% of his portfolio amount per trade and not to trade more than 1% per investment call.
Eg: If you have Rs 5, 00,000 as trading capital, then you can only risk 10,000 per trade. One should derive stop loss from the technical structure. SL is a price point which states that your analysis has gone wrong.
Position size= Amount of Risk Per trader (Entry Price- Stop Loss Price)
Position sizing for the Small amount
The above formula is for big accounts but for small it differs many times. E.g. if you have 1, 00,000 as trading capital then risk amount per trade is Rs 2000. Here is the position sizing
Entry Price- Rs 1500
Position Sizing = 2000/ (1500-1485) =133 Shares
To buy the shares you need to have 2, 00,000 in trading account (133*1500). It is not wise decision to invest entire capital on one trade.
So you can invest 5% or 10% of your portfolio amount per trade. Also you can buy 5 or 8 shares assuming 10% Investment per trade.
Must Read : Risk Management for Stock Market
Risk management for stock market skill is also essential for successful intraday trader to know. There are four type of trade like small profit, small loss, big profit and big loss. So here are the golden rules for Risk management for Stock Market.
- Always Trade with RPT (Risk Per Trade)
- RPT works with Quantity
E.g. if RPT is Rs 2000, SL= 10 points then Quantity = RPT/SL i.e. 2000/10 =200
- Always consider risk to reward more than 1:3
- Always use RPT for Intraday or swing or Positional Trade
- RPT can be increase or decrease based on our decision
- Always follow proven system and plan
- Cut the losses and ride on profit
- Always consist the order size
- Avoid getting out and in of the market soon.
- Never ever over trade
- Always trade with active stocks
- Try to balance your emotions
- Monitor your result and make a report of it
Dear Trader, Without Risk Management Market Never Generate Profit.