TheDueDiligence...'s  Instablog

Send Message
A report dedicated to providing investors with the truth about the stocks flooding their inbox's.
My company:
The Due Diligence Report
My blog:
The Due Diligence Report
  • Due Diligence: The Importance Of Risk Management 0 comments
    Apr 7, 2013 11:39 PM

    When it comes making an investment, managing your risk can affected your trade in ways you never thought possible. And in this business of trading stocks, risk management is one of, if not THE, most important aspect of the business. Because at the end of the day, all we are doing as traders, is determining how much money we are willing to risk, to try and turn a profit.

    The first, and most important, thing you need to figure out when you are managing your risk, is how much money you are willing to risk losing on a single trade. This % will most likely be different for each trader since some can afford to lose more than others, but for the most part people usually will risk 2% on the conservative side, up to 5% if they are feeling a little more aggressive and can afford the loss.

    At first it may seem like there can't be that big of a difference in risking 2%, compared to 5%, compared to even 10%, but over the long run, it can make a WORLD of difference.

    Just take a look at this chart below . This is showing the difference between what % of your account you will need to make back after only 4 losing trades in a row to just break even.

    (click to enlarge)

    After only 4 losing trades, risking 10%, you would need to make over an astonishing 50% of your equity just to BREAK EVEN! Where as if you properly manage your risk, and only risk 2% of your equity each trade, you will only need to make 8.42% of your equity to break even.

    There is a TREMENDOUS difference between having to only make 8% of your equity, compared to 50% of your equity. It will be drastically harder to recover from 4 losing trades in row(which is very common) if you need to make 50% of your account, than it will be if you only need to make 8%. And I don't know about you but I would much rather only have to make 8%, compared to 50%.

    The second major thing managing your risk can affect is your position size. A lot of traders, I know I used to do this, just buy 1000 shares of XYZ, no matter what the price is in relation to where they set their stop loss.

    For example lets say XYZ is trading in a range of 2.07 a share to 2.15 a share. And you determined that you will cut your loss if the stock dips to 2.02.

    Now most people(including my old self) would likely buy 1000 shares of XYZ if it was at 2.07, 2.09, or 2.15. It doesn't matter the price, because in my head I want 1000 shares so I can make 10 dollars a point.

    This is how most people trade. They will buy 1000 shares of XYZ no matter where it is in relation to their stop loss. But the trader who knows how to manage his risk, know his position size will very different depending on the price he buys the stock.

    For example, Lets say our trader is willing to risk 2% of his account on this trade(so $100) and his stop loss is set at 2.02.

    Lets say he can buy the stock at 2.12, and is only wanting to risk losing $100 if the stock goes to 2.02. he will buy 1000 shares.

    Now lets say he can buy the stock at 2.07, and he still only wants to risk losing $100 if the stock goes to 2.02. He would then buy 2000 shares.

    In both examples each trader is only risking $100 dollars if the trade goes to 2.02. But each traders position sizes are drastically different. This is because of Risk Management.
    This is how knowing how to manage your risk, can greatly affect your position size.

    My old self would buy 1000 shares whether I could get it at 2.12 or 2.07. But now since I know how to manage my risk, I know that I can buy 2000 shares if the stock is at 2.07, and I should only buy 1000 shares if it is at 2.12, and even if the trade goes wrong, I will still only lose 100 dollars, even though the position sizes are totally different.

    I hope this shows any traders reading this how important managing your risk is. Because at the end of the day, there is a big difference in having to make 50% of your account to break even, and having to make 8% to break even. Just like there is a big difference between buying 1000 shares, and 2000 shares. And if you know how to properly manage your risk, your loss will still only be $100, whether you bought 1000 shares, or 2000 shares.

    Remember Folks, always do your make sure to do your Due Diligence!

Back To TheDueDiligenceReport's Instablog HomePage »

Instablogs are blogs which are instantly set up and networked within the Seeking Alpha community. Instablog posts are not selected, edited or screened by Seeking Alpha editors, in contrast to contributors' articles.

Comments (0)
Track new comments
Be the first to comment
Instablogs are Seeking Alpha's free blogging platform customized for finance, with instant set up and exposure to millions of readers interested in the financial markets. Publish your own instablog in minutes.