Managing risk in trading is all about keeping losses small and your winners big. In the previous post I talked about how to calculate Reward : Risk in a trade and that the aim is to only enter trades that offer at least 3:1. In other words aiming for gains that are at least three times the losses. I (in the first post) also talked about parameters to choose your position sizes according to skill level (proven edge), trading capital and type of account. Next is to determine the number of shares for a new position.
For example, I determine that I am only willing to risk $50 on anyone trade because I only have $30,000 in my margin account where I trade with a frequency of 50-60 trades per month. Since I am still learining and have no real edge, that means that if I have two really bad months in a row I could be out of the game. If I know where my stop and entry prices are for a trade, with a good R:R, then I can calculate the number of shares (Position Size) I need to buy with the following formula:
Quantity = $Risk / (Entry – Stop) For Longs,
Quantity = $Risk / (Stop – Entry) For Shorts.
For example, I am looking to buy BTU at $47.75 with a stop at $45.98 and risk $50.
Quantity = 50 / (47.75 – 45.98) = 28 Shares.