Over the past week, major indices have been very volatile. Without a clear direction of the indices, volatility has increased, which makes prices fluctuate faster and therefore harder over time. However, times like this demonstrate the importance of risk management and, if done correctly, can help preserve the trader’s capital.
That said, let’s review a simple example of how to manage risk based on a fixed amount of trading capital.
First, you need to know how much money you are trading. For this example, we will use $ 10,000. Next, we need to find out how much we are willing to risk in a given trade. A good rule of thumb is to risk only 1-2% of the total commercial capital of any operation. Because we chose an account size of $ 10,000, our dollar risk would be 100 or 1%.
Still, that doesn’t mean we only buy stocks worth $ 100. To get a better idea, we can use the following example.
If you buy the XYZ symbol at $ 30 per share and your risk (the price you will get if the trade goes against you) is 26, you can buy 25 shares or a value of $ 750 in XYZ. The calculation is (entry – risk), then the dollars were risked ($ 100) / (entry – risk)). Tan, 30 – 26 = 4 then take 100/4 = 25.
Although the amount of money used per transaction will vary, the amount you risk will always remain at 1% of your trading capital. This allows you to manage risk consistently, and therefore losses are less likely to escape you in today’s volatile market.
Another quick tip is that if you typically risk 1% per trade and observe a more unfavorable market environment, you can always reduce your risk by up to 0.5% or an amount that you risk comfortably per trade.
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- S&P 500 (SPY): I am waiting for new maxims.
- Russell 2000 (IWM): 225 resistance.
- Dow (DIA): 351 area of resistance.
- Nasdaq (QQQ): 360 support.
- KRE (regional banks): 60.32 supports the 200-DMA.
- SMH (semiconductors): 262 new support areas.
- IYT (transport): 253.66 10-DMA resistance.
- IBB (Biotechnology): New highs of several months.
- XRT (retail): 97.22 resistance.
Deputy Director of Research and Education in Trading