Today we are going to talk about trading risk. What is trading risk? Risk can be how much you are willing to lose or it could be how much you are willing to put up on a trade. How do we determine how much to buy and where our stops should be? First let’s talk about stops.
Trading Risk: Stops
I have back tested good systems with many data points. When a trader risks more than 2% they are getting in very dangerous territory. Let’s do some examples.
Our systems use between 1% and 2%. It is critical that stops are set before trading begins. Always get out when you stop is hit. The stop does not change between 1% and 2%. Your system either uses 1% or 2%. If you change the stop on every trade then you are changing your system. This number should never change.
Trading Risk: How much should I Buy?
As a new trader, I broke all the trading rules. Once I had a futures contract that was worth over $100K. The trading account only had $10k in it. This was the margin requirements for that contract. I did not have a 2% loss set I also did not have any concept at all of how many contracts I should be buying. In my mind I thought if they let me buy it then it must be ok. I found out how little I knew very quickly.
This is how I felt.
That is a funny story but it is similar to what I experienced when I traded with too much risk.
Trading Risk: Real Life Example
My trade was in a silver contract. I was buying based off of some advice. The advisor did not tell me how much to buy. I bought it the night before and by 9:15 the next morning I was up $2000 on a $10,000 account.
Trading Risk: UP
Dreams of grandeur entered my mind. What will I do with all this money. What if I triple my account? I’m such a genius trader. At 10:00 am 45 min later I was up $2500. By 10:15 I was up $3000. At this point I became pretty emotional. I’m at work checking my phone constantly. Little did I know there was a meeting of the federal reserve.
Trading Risk: Down
Someone in there said something that upset the silver market. By 10:30 within 15 min my genius trade had gone from being up $3000 to being down $4000. You can imagine my emotions at this point.
I started thinking what am I going to tell my wife. How could I be such an idiot. In my mind I went from being the best trader in the world to being a complete idiot within 15 min. I constantly watched it and said if it gets back to even I’m out.
I don’t know what the feds said to make it go bad but they said something else that made it go back up. When it got back to even I got out. I continued to check the silver price that day. If I would have stayed in by the end of the day I would have been up 10K on that trade. By the end of the week I would have been up 30K. That was a ride and I felt like that man in the above video.
It was a stupid investment because I was taking way too much risk. If I would have had my risk right. There would have been know stress the trade would have been a good trade. I would have made a lot of money. I would not have made 30k but I might have made 15% in a couple of weeks.
Trading Risk: Questions
When you are thinking about how much you should buy you should think about a few factors.
1) How much money is in your account?
2) How high is your stop?
3) How much volatility is in the market?
If a stock has been moving 10% per day then you are going to buy less than if it is moving 1% per day.
You’re probably going to buy more if your trading bonds vs stocks. There is more volatility if in stocks than it is bonds.
It is very important that we understand how much risk we are going to take before we ever enter the trade. Just as buy and sell signals are calculations how much to buy is also a calculation. Risk can make or break an account. Risk is one of the most important factors in trading.
Understand Risk: The Gold Trading System
If you want to understand risk join our gold trading system its free at the point of this post. You can see how much you should be risking when you are trading gold.