Risk management or money management is an integral part of trading because whatever the strategy one implements one has to always implement a risk management policy in order to succeed over the longer period of time , because if one doesn’t has any risk management policy one can loose all the profits accumulted over multiple trades just in a single bad trade .
So how can me make sure that we take the same amount of risk everytime irrespective of the cmp of the stock , let us learn the basics through an example – suppose if you had a trading capital of Rs. 500000/- , the total risk that you want to take should not be more than 1% or 2% of the total capital , so if we risk 1% then maximum that we can loose is 5000 rs only , so if we have a strategy with a Risk to reward ratio of 1:2 then max we can loose is 5000/- if market goes against us and our profit is 10000/- if we turn out to be right , so setting a maximum loss amount and having a good reward to ratio in a trade makes sure that we don’t loose all our profits back to the market.
Now we have determined the max loss % but how do we calculate the number of shares to buy or short ? Simple , just divide your 1% maximum loss of Rs. 5000 by the stop loss and we get the maximum number of shares you can buy to keep yourself from losing more than 1%of your capital .So now you must be thinking what is Stop loss , stop loss is a level we have to choose to get out of the trade if the trade goes against us , there are different startegies to choose your stop loss , we may discuss them in future posts .
Continuing our example above if 5000 is the max we have decided to loose and if the cmp of a stock is 100 Rs and we have set a stop loss of Rs. 20 then the shares we have to buy equals 5000 divided by 20 which gives us 250 , hence we buy 250 shares at cmp of Rs. 100 thus blocking our Rs. 250000/- in this trade.
The above mentioned procedure can be used to get the number of shares to buy in order to keep your loss under 1% if the trade goes against us , one can also risk upto 2% but not more than 2% should be ever risked on a single trade , you may profit more by risking more but there is a larger chance of losing your capital by riskingnmore than 2% on a single trade.