Online Stock Trading Tips

One of the most important skills in any investor is the ability to assess and quantify risk. It is because; if you are able to measure the risk involved, it can help you decide whether it is a good or a bad investment.

The same principle applies to stocks. In stock trading, it is primarily important that in any money management strategy, risk management should be carefully considered. If you risk too much, you will end up losing your entire trading capital before it will be able to make substantial profit for you.

If you risk too less, growth of your stock trading returns will be very small and negligible. In stock trading, professionals are considering some standards when it comes to risk as well as the ways of measuring it up. It has been a widely accepted practice that “money management” and “risk management” is even more important than picking just the correct stocks to trade.

Because of this importance, it is a requirement that every trader should learn risk management and integrate that to their trading system.Below are the important steps in order to execute risk management in any stock trading activity:

Step 1: Determine how much to risk. In stock trading, most traders are risking 1% to 2% of their investment capital in any one trade. Of course if you need to play very risky 2% is the most advisable while staying within the safe zones. More than 2% is not recommended due to the uncertain nature of the stock market. The most recommended is 1.5%

Step 2: Calculate the risk amount in dollars based on your entire trading capital. If your risk percentage is 1.5% and your current trading capital is $20,000; then:

Risk amount in dollars = 1.5% x $20,000 = $300

This means that; you find it “willing” and “acceptable” to lose $300 in any one trade. If you find this too risky, then you might consider lessening your percent risk and it is fine. For example, you might further lower it down to 1%.

Step 3: Calculate the price you are risking per share. In order to calculate, you need the following data:

a. Current stock price
b. Your money management formulated sell stop

For example, say you need to enter a long trade at a stock price of $10 and put a money management “sell stop” at $8, then:

Price you are risking per share: $10 – $8 = $2

Step 3: Finally calculate the number of shares you can purchase based on your calculated risk. Formula:

Number of shares to be purchased based on calculated risks = Risk amount in dollars/Price you are risking per share

Let’s compute the number of shares you can purchase based on the above example. The following is given:

Risk amount in dollars = $300
Price you are risking per share = $2

Number of shares you can purchased = $300/ $2 = 150 shares

Step 4: Execute the order with your trading broker, so this means you can execute a buy order using the following conditions based on your calculated risks:
Buying price/entry price = $10
Sell stop = $8
Number of shares = 150 shares

By calculating the risk and integrating it to your trading, it ensures that you have a long life trading capital and will be able you to stay longer in trading which is essential for profit growth.

Related posts:

1. The Principles of Money Management in Stock Trading
2. Trading for a Living, Psychology Trading Tactics Money Management – Book Review

This entry was posted on Sunday, May 2nd, 2010 at 7:18 pm and is filed under Paper Trading. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.