| One of the most critical things to consider when | | | | our trading capital. |
| trading Contracts for Difference [CFD's], stocks and | | | | POSITION SIZE |
| shares is the management of risk. Given that risk is | | | | So, here's the equation for working out how many |
| magnified in proportion to the amount of leverage or | | | | shares to buy- |
| deposit used, we need to tread very carefully. | | | | POSITION SIZE = RISK CAPITAL/ RISKso our $1000 |
| First let's look at a traditional trade of shares or | | | | is divided by $0.50 to give us a figure of 2000. |
| stocks | | | | 2000 shares X $0.50 = $1000 which is our 'agreed' |
| Let's say we identify an opportunity to buy company | | | | risk. |
| ZYX at $10 as it has satisfied the rules of our 'trading | | | | So we can purchase 2000 shares of Stock ZYX, but |
| system', the stop loss for the trade is $9.50 if the | | | | in this example we are limited by our account size - |
| trade does not turn out as expected - this equates | | | | $10,000. |
| to a risk of .50 cents per trade. This is step one. | | | | Were we to buy the full 2000 shares we would need |
| Step ONE | | | | to find $20,000 in capital.... this is where CFD's or |
| Identify Buy price $10.00 | | | | margin accounts are VERY useful. |
| Identify Stop Loss $09.50 | | | | IF we buy 2000 CFD's of the stock ZYX we would |
| Map Risk $00.50 | | | | only need to put down a deposit of 5% of the |
| The next thing we do is to work out our position | | | | $20,000 stock value |
| size based on the AMOUNT OF RISK we are willing | | | | (2000 X $0.50) X $10 / 5% |
| to accept. | | | | Deposit to HOLD $20,000 CFD's of stock ZYX = |
| If you have a trading system that you have | | | | $1000 |
| historically tested to be accurate and you are VERY | | | | Now we just need to sit with the trade to see if it |
| confident of it performing well into the future then | | | | turns out as we EXPECT or lose the 'agreed' amount. |
| you could consider using 10% of your account per | | | | Let's say that our target - because any good 'Trading |
| trade. This means you would have in the worst case | | | | system' should have exit targets to sharpen the |
| scenario 7 to 9 losing trades before all your money | | | | mind- let's say an exit was signalled at $10.30 - we |
| disappears. | | | | would make $0.30 on each share , so: |
| Professional traders, fund managers and floor traders | | | | A profit of $0.30 per share on 2000 shares of ZYX = |
| are well aware of the road kill left over after new | | | | $600 profit. 2000 X $0.30 = $600 |
| traders come out with all guns blazing and and are | | | | If the trade had not turned out as planned the |
| crushed by the juggernaut of the real world of | | | | equation would be as follows: |
| trading, meanwhile the professionals just keep | | | | A loss of $0.50 per share on 2000 shares of ZYX = |
| plodding along.... risking their 1% to 2% of account | | | | $1000 loss. 2000 X -$0.50 = -$1000 |
| and steadily building profits over time. If one to two | | | | So there you have it let's recap: |
| percent sounds boring let me let you in on a little | | | | Step ONE |
| secret.... if you are trading for excitement you're not | | | | Identify Buy price $10.00 |
| going to last long! In my experience profits that | | | | Identify Stop Loss $09.50 |
| come fast also go fast, until you get your mindset | | | | Map Risk $00.50 |
| right about money. | | | | Step Two |
| Let's assume we have $10,000 in our trading account, | | | | Identify how much of your trading account you are |
| if you didn't know any better you might think | | | | willing to put at risk in our examplea 10% risk on a |
| $10,000, great! Let's buy $10,000 worth of stock - | | | | $10,000 account = $1000 |
| WRONG - this is GAMBLING which is significantly | | | | Step THREE |
| different to TRADING. | | | | IDENTIFY POSITION SIZE = RISK CAPITAL/ |
| Using the previous example let's say we are willing to | | | | Mapped RISK |
| lose a maximum of 10% of our trading capital - we | | | | So our $1000 [10% 0f $10,000] is divided by $0.50 |
| could equate this to having $100 in your pocket in | | | | [STEP ONE] to give us a figure of 2000 shares. |
| $10 dollar bills and losing one $10 bill. You wouldn't | | | | If you cannot trade CFD's but have access to margin |
| mind so much I imagine, but if you had a single | | | | lending you can apply the same principles, though of |
| hundred dollar bill and lost that you'd be 'feeling' | | | | course you would also need to be aware of the |
| pretty annoyed wouldn't you, so for the sake of | | | | 'leverage ratio' as required by your lender. |
| sanity we'll assume we are 'OK' with losing 10% of | | | | |