Monthly Archives: March 2010

Stock Lesson 7 – Risk, Money Management

Always put a protective stop loss once a stock is bought!

The stop loss could by 1 or 2 Average True Range (the approximate variation a stock does on e.g. daily basis i.e. if you are looking at daily charts). Or the stop loss could be one or 2 points below the last low the stock made. What ever the criterion you choose to put a protective stop loss, calculate the per unit risk which is the price the stock – stop loss price i.e. the money you can loose on the stock if stocks goes in the wrong direction and hits the stop loss.

Rule: The total risk on all your stocks should never exceed 2 percent of your total trading money.

e.g. You have 10000 to trade with. 2% of 10000 is 200 dollars. Bought AT&T 9symbol T) at 24.95 and placed protective stop loss at 22.95. Risk per stock is 2. Since the total maximum risk you are allowed to take is 200, you can buy 200/2 i.e. 100 stocks of T. If you buy more than you are taking more risk than necessary.

Also only trade those setups that you think are going to give atleast 2wice or 3rice your risk. In the above trade you are doing the trade because you expect the stock price to jump 4 or 6 dollars from the current price of 24.95 vs your stop loss of 2 dollars below the current price. i.e. you reward to risk ratio should be 3 or above before you get into any trade. See the coin toss analogy (lesson 10).

Moral:
Trade with small risks (i.e. less than 2% of equity). This way you can sleep tight without ever loosing a lot, yet making decent profits.