Risk Management In Stock Trading
Risk management in stock trading is the most important part of learning how to trade stocks. It’s the reason 90% of traders lose in the market. Without proper risk management you are sure to fail. The best stock traders practice good risk management and know what tools to use to calculate risk. You need a good stock position size calculator on hand to know beforehand how many shares to take on, your stock entry point and your stock exit point. In this blog post we’ll cover those details and also show you our position size calculator for stocks.
Risk Management in Stock Trading – Risk Management In Forex too!
Risk management is learning how to manage risk while in a trade. Everyone knows that when starting out learning how to manage your risk is often the most overlooked part of learning how to trade stocks. If you don’t know how to manage your risk you are certainly bound to fail.
So, how do you do it?
Learn to cut losses correctly, and quickly and use a share size calculator. This is one of the most basic forms of risk management in the book. If you cut your losses as quick as possible your losses should always be smaller than your winning trades. The idea here is that you exit a trade as soon as you realize that the stock move is not going your way. It’s hard to get used to this. It will drive you insane when starting out. But, if you cut them quick, you can live to trade another day.
You Need To Have A Plan
Without a good plan to enter and exit a stock you are, honestly, trading blindly. You should know going into a trade how large your position is, your entry and exit points and the amount of risk you are willing to take on with regards to the percentage of your account. Your plans may not always be accurate when you start out trading but they will get better with time. Eventually, you will be able to do quick calculations in your head for position size based on your entry and exit points.
You need to have a predetermined entry point and exit point based on areas of support and resistance, the patterns your are playing and an overall good feel for the market conditions. When you start getting better at risk management by cutting losses efficiently and effectively you’ll start to become profitable as a trader. Sometimes you will cut a winner too soon. We all do it. But as you become better at risk management in stock market you will learn to live with those that you exited too soon. It’s just part of the game. At some point it will click and you will start to cut losses and take in winners more intelligently. Oftentimes it is better to cut losses too quickly than to stay in a losing trade.
The key here is to live to trade another day and build consistency. You need to keep your account safe. We’ve seen too many people BLOW up their accounts and then get out of trading altogether. It happens every day.
Get Better At Your Entry Points
The best way to get better at your entry points is to set up a demo account and paper trade for a while. (You can set up a demo account for forex or stocks here. There are several to choose from.) When we started out we paper traded and practiced for over 6 months until we got better at entry and exit points and also risk management.
Here are three things you can do to get better at your entry points:
- Predetermine points of support and resistance
- Focus on one pattern and learn it well
- Always have a trade plan, know your share size, entry point and exit point
Sounds easy and it really is once you get used to it.
If you know the resistance points of a particular stock/forex this will give you an idea of when a stock will bounce or pull back for a consolidation. Knowing the resistance points makes it easier to create a plan to enter and exit a stock.
What are resistance points? They can be previous highs or lows. If you are day trading then look at the pre-market highs and lows and then when the market opens watch as the stock moves up or down. As it approaches a resistance level then you may want to exit or enter a trade, depending on whether you are going long or short.
Share Size Calculator – How to Use Position Size Calculator
You need to have a good way of determining your share size and a share size calculator will help you develop good position sizing strategies. We’ve built one that you can use for free here. We use it every day, still. You never want to risk more than 2% of your account size on any trade. Some traders go a little higher than that regularly. We recommend staying under 2% of total account size.
Here is a good position sizing example: There is a stock that you like and your entry point is $4 and risk you are willing to take on as an exit is $3.80 and your total account value is $1000 then the max you want to risk is $20. So, you could buy up to $200 of a stock as long as you are willing to get out at no less than $3.80. Anything less than $3.80 is over the $20 max loss you are willing to lose. Check out our position sizing software here.
There is no set position sizing formula that is a one size fits all. No one can tell you the best position sizing method. It really depends on your risk tolerance, your style of trading and your account size. So, if you are like us when we first started we were pulling our hair out trying to find the ONE that we should use. Bad news; there isn’t just one. You have to use the basics that we’ve recommended and then try to develop your own and use our share size calculator to determine your best position sizing method.
Our share size calculator works for swing trading position sizing as well. Have a look at it.
No Standard Risk Management Blueprint
There is no standard risk management blueprint. Just like athletes that play their sport with a particular style, so too, do stock and forex traders have their own risk management style.
So What Have We Learned About Risk Management In Stock Trading?
Basically, you need to keep your winners bigger than your losers and you need to use a good stock position size calculator. And, if that was easy then everyone would be doing it. But, you have to understand that losing is part of trading and you need to embrace it. As long as you manage your risk then you can lose on 3 trades and win one trade and make up for all the prior losses. True story. It happens to us every day. We will get on a losing streak then one stock will pop and make up for all the losses.
You need to learn how to get consistent and that comes with getting more screen time. The more you trade the better you will get. We promise you that. We highly recommend setting up a demo account and paper trading before putting your own money at risk. For stocks, we started out on ThinkorSwim then moved to TradeStation. You can choose whichever platform you want and depending on what country you are from will likely determine which account you choose.
We have reviewed brokers from all over the world. Want to set up a demo account? See our “Find A Broker” link and have a look.
If you are new and want to learn more about how to trade stocks, forex or cryptocurrency then have a look at our free training courses here.