Basic money and risk management for traders. | by Dimitrios Gourtzilidis | February 2022

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Step 1. Maximum risk amount

Each trader starts by funding their own account and starts buying assets to trade. When we buy an asset, we link some of the funds in our account to that asset. If its price goes down, we lose money and so on. It is wise not to use all the funds in our account at once, but rather to risk a small part of them with each transaction. We need to treat our account like a business, would we open a shop and donate all of our funds at once?

Therefore, any trading strategy will at some point involve an allocation of a risk taken per trade, as a percentage of our entire account. It is common in many strategies that 2% of the entire account should be at risk with an open position, and no more. If our entire account is $100, we are allowed to risk $2 per trade.

Similarly, if we have 5 open trades with a risk of 2% each, our total amount of risk is 10%. This should also be managed before entering trades.

Step 2. Risk/reward ratio

After calculating the maximum amount we can risk, we decide if we are going to divide this amount into one or more trees. Of course, we should act on the opportunities the market presents us with and not go against our beliefs about the market.

By using various tools such as support and resistance lines, Fibonacci levels or any other technical analysis tool, we can identify possible entry and exit levels for our trades. It would make sense to enter trades that have a higher reward than risk. For example, if we identify a stop loss level around $80 and an entry level around $100 and a price target at the $120 level, then we are risking $20 to gain $20. This trade would be at the limit of the accepted trade, with a reward risk level of 1:1. If, on the same trade, our target price/profit level was around $140, our risk/reward ratio would be 1:2, and that would be perfect.

Step 3. Move percentage

We can calculate the percent movement of an asset with the following equation:

Step 4. Position Size

After all the calculations above, we need to connect the maximum amount we can risk with the trade we are about to take. This is called position sizing.

With the following equation, we can calculate our position size, after setting our stop loss.

Of course, if we are about to make more than one trade, we need to divide the “dollar risk amount” by the number of trades we are about to open. Please note that these figures are indicative only and are not set in stone. These numbers should be adjusted based on trading strategy and risk tolerance.

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