The market looked pretty nasty today and for most people, probably felt pretty nasty too. It doesn’t matter how good your system is, without good risk management-given enough time, you WILL be knocked out of the market. Even if you had a system that produced 90% winning trades (I’ve never seen such a system), if you ignore risk management, given enough time, you’ll be taken out. In trading there are a lot of odds stacked against you. You need to be right on the stock, right on the entry, right on the exit, right on the direction of the overall market and you need to place a trade that is large enough to produce a meaningful gain. At the same time, if your trade is too large, the risk can overwhelm your portfolio. Imagine that you do have that 90% winning system and you place all of your eggs into one basket on each trade, 1 bad trade could cut your portfolio in half. Often losing trades have a tendency to spiral out of control. So check out the video and then read the note afterward below the video.
There is another way to allocate your portfolio using the 2% rule. You can decide how many positions you want to trade at any one time and then spread the 2% risk among them. Lets take the example from the video-you have a $10,000 portfolio. You want to trade 5 positions at any one time, your 2% portfolio risk exposure=$200, so each of the 5 trades will be allocated $40 of risk capital. Lets say you are considering a position for the portfolio, the stock is $10 and your stop is $.50 away from your entry. Divide the $40 allotted risk capital by the .$50 risk and you end up with 80 shares or a $800 position. Obviously this way of allocating risk is much more conservative, but if you trade in and out of a lot of positions, you may want to consider this approach. After all, even at the original 2% risk presented in the video, if you are wrong 10 times in a week, you have an approximate loss of over 20% of your portfolio. If you are an active trader, I suggest considering this method. You can make the system work, but you need to enter positions that are very close to your stop. Plug in $.10 risk on the above example and then you get a position size of 400 shares rather than 80 and a $4000 position instead of a $800 position. You just dramatically improved your risk/reward ratio while maintaining the same risk exposure. Just something to chew on. Protecting your portfolio is a lot easier than making the lost money back-so if this video helps save you some money, consider dropping a coin in the tip jar at the top of the blog.