For the past week, the major indices have been very choppy. Without clear direction in the indices, volatility has increased making price swings faster and, thus, tougher to time. However, times like this prove how important risk management is and, if done correctly, can help preserve trader's capital.
With that said, let's go over a simple example of how to manage risk based on a set amount of trading capital.
First, you must know how much money you are trading with. For this example, we will use $10,000. Next, we need to find how much we are willing to risk on any given trade. A good rule of thumb is to risk only 1-2% of your total trading capital on any one trade. Because we chose an account size of $10k, our dollar risk would be $100 or 1%.
However, this does not mean we are only buying $100 worth of stock. To get a better idea, we can use the example below.
If you buy XYZ symbol at $30 per share and your risk (price you will get out if the trade goes against you) is 26, then you can buy 25 shares or $750 worth of XYZ. The calculation is (entry – risk), then dollars risked ($100) / (entry - risk)). So, 30 – 26 = 4 then take 100/4 = 25.
While the amount of money used per trade will vary, the amount you will be risking will always stay at 1% of your trading capital. This allows you to consistently manage your risk, making it less likely for losses to get away from you in the current volatile market.
Another quick tip is, if you normally risk 1% per trade and notice a more unfavorable market environment, you can always scale back to 0.5% risk or an amount that you are comfortable risking per trade.
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- S&P 500 (SPY): Watching for new highs.
- Russell 2000 (IWM): 225 resistance.
- Dow (DIA): 351 resistance area.
- Nasdaq (QQQ): 360 support.
- KRE (Regional Banks): 60.32 support the 200-DMA.
- SMH (Semiconductors): 262 new support area.
- IYT (Transportation): 253.66 resistance from the 10-DMA.
- IBB (Biotechnology): New multi-month highs.
- XRT (Retail): 97.22 resistance.
Assistant Director of Trading Research and Education