Why only 1% Capital Risk when trading

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Old Jan 12, 2005, 12:33am   #1
Joined Jul 2001
Why only 1% Capital Risk when trading

Hi, I know we have "Money Risk Management" forums but I was thinking it may get more exposure (IMHO that, I think it deserves)

I have been researching various trading methods, for six months, that may or may not give me an edge in trading. I now want to move onto another part of my research. HOW NOT TO LOSE MY SHIRT.
I have often seen it mentioned that we should only risk at any time 1% or 2%( if your a high roller) of our trading capital at any time.

What I hope is that some members might enlighten me(and other newbies) with real experiences of what are the consequences of not listening to this rule. Also what are the real benefits of using a robust Money & Risk Management System.

Maybe also, what are some of the Physiological pitfalls that might be waiting to pounce.

Thanks
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Old Jan 12, 2005, 12:40am   #2
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I think that the idea is to keep a trading capital even when you hit a losing streak.

If you hit a bad run of trades with 10% at risk on each one, you are out of the game quick.

If you keep to a small %, then you can take a greater number of losers and still have an account to trade your way back up again with.
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Thanks! The following members like this post: ford
Old Jan 12, 2005, 12:55am   #3
 
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Most good systems can have 10 losers in a row, add in slippage etc you can easily see your
self down 12% (using 1% per trade), or 25% assuming you are using 2% per trade.

If you use 3%-5% then you could get drawdowns of between 30 and 50%.

A 10 or 20% drawdown does not require that much more effort to get back to breakeven but a
40%-50% drawdowns require a very high rate of return to get back to breakeven:

A 10% drawdown requires a 12% return to get back to breakeven.
A 20% drawdown requires 25%.
A 25% drawdown requires 33%.
A 33% drawdown requires 50%.
A 50% drawdown requires 100%.

Its unwise to risk more than 2% unless you have a system with small drawdowns (high win rate, giving
few losers in a row etc).
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Old Jan 12, 2005, 1:30am   #4
 
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Well put DD.

Also there is the psychological burden incurred when risking an amount in excess of one's comfort threshold. A 1% loss is less likely to lead to a sudden failure of discipline than a 10% one.
Although 1% sounds small one can still return a surprisingly large amount on capital with a good system.

Personally speaking, the result of risking more than 1%-2% was the loss of half my capital in a few months. I wouldn't advise it unless you are a brilliant trader
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Old Jan 12, 2005, 1:36am   #5
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Gardan started this thread Ardhil/donalduke thanks, what is the realtionship between capital risk and where a stop loss risk is.
By that, I mean as I understand it the calculations to get to a 1% risk base is from my total capital fully margined (is that correct?) capital.

But if I place a stop loss say 10 cents away from entry on the purchase of 1000 $50 shares is my risk $100 (10c stop x 1000 shares = $100)

or is it 1000 x $50= $50,000. if so why. Is it possible to experience 100% slippage on a stop loss.
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Old Jan 12, 2005, 3:48pm   #6
 
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You're right, Gardan.

The stop loss IS the key element here. You wouldn't get anyway trading only 1% of your trading capital. Your stop loss is your risk thus should be tallied as such to make up your 1-2%.

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Old Jan 12, 2005, 7:23pm   #7
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Your risk exposure on the above trade is $50K and I know of cases where people have been over exposed and lost everything in their margin account and also owed money they did not have. The simple rule to follow is this: Do not enter a trade where your exposure is greater than your account balance.


Paul
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Old Jan 12, 2005, 7:55pm   #8
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Thanks Paul

Gardan started this thread
Quote:
Originally Posted by Trader333
Your risk exposure on the above trade is $50K and I know of cases where people have been over exposed and lost everything in their margin account and also owed money they did not have. The simple rule to follow is this: Do not enter a trade where your exposure is greater than your account balance.


Paul
Hi Paul,Just to clarify that, do you mean Unmarginned account.

Therefore with say $20k capital (unmargined) in your account, one would be limited (using the 1% risk rule) to trading only one 1000 lot size on a $20 stock-with a 20c max stop loss. Or 500 lot size on a $40 stock-20c stop loss, and so on. Is this correct?

Also if possible can you expand on how they lost all there money , did they use stops? and why is the stop not the risk point. Are stops unreliable? or are they just a safety net.
Without trying to sound rude , why can't a stop be used as the calculation.

This may sound like I wish to use the stop as the calc, not so, I just wish to understand my risks before I start trading live.

Roll on 2020.

thanks
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Old Jan 12, 2005, 9:17pm   #9
 
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Quote:
Originally Posted by Gardan
Hi Paul,Just to clarify that, do you mean Unmarginned account.

Therefore with say $20k capital (unmargined) in your account, one would be limited (using the 1% risk rule) to trading only one 1000 lot size on a $20 stock-with a 20c max stop loss. Or 500 lot size on a $40 stock-20c stop loss, and so on. Is this correct?

Also if possible can you expand on how they lost all there money , did they use stops? and why is the stop not the risk point. Are stops unreliable? or are they just a safety net.
Without trying to sound rude , why can't a stop be used as the calculation.

This may sound like I wish to use the stop as the calc, not so, I just wish to understand my risks before I start trading live.

Roll on 2020.

thanks
Hi Gardan

I think Paul is referring to a situation where there is some event on the stock causing it to be suspended, when the stock re-opens it could be at a significantly reduced price (assuming the event was perceived as bad for the future prospects of the company). Thus the stop would have no effect and the actual loss when closing out the position could be significantly larger than the amount risked down to the stop loss.

Stew
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Old Jan 12, 2005, 9:31pm   #10
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I have a margin account and regularly enter trades for a larger amount than the cash I have in the account. So although I am risking far more than 1%-2% of my capital, I close out a loosing trade very quickly.

The way I manage my risk is to
1. Only enter one trade at a time so I can concentrate on that trade and nothing else.
2. I donít trade really fast moving stocks. That way even if a trade turns bad on me itís not likely to move too far in the wrong direction before I can exit it.
3. I only trade intra-day and exit any positions by the end of the trading session. That way I am not affected by overnight news etc.

IMO the key to successful trading is the ability to take a loss and move on without dwelling too much on it. No matter what your trading 'edge' is you will loose money and may have a run of loosing trades (especially when you first start out). So trade small and trade as safe as you can and make sure that you don't wipe yourself out.
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Old Jan 12, 2005, 10:03pm   #11
 
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Another way of looking at the 1%/2% risk per trade is by risking these small amounts your allowing enough time to reach your expectancy. If you tested your system and you were profitable 60% of the time, then your giving yourself enough time to reach that expectancy. You may well have a system that is more than 60% right but if you gunsling with your money management you may never reach those profits. Risking a small amount per trade allows you to let your edge come to the surface and lets you to ride the bumps of a early prehaps unexpected drawdown. Your edge may only be slight but tight money mangement will help us all achieve our trading goals.
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Old Jan 12, 2005, 11:05pm   #12
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thanks KM

Gardan started this thread
Quote:
Originally Posted by theknifemac
Hi Gardan

I think Paul is referring to a situation where there is some event on the stock causing it to be suspended, when the stock re-opens it could be at a significantly reduced price (assuming the event was perceived as bad for the future prospects of the company). Thus the stop would have no effect and the actual loss when closing out the position could be significantly larger than the amount risked down to the stop loss.

Stew
Do you know how often this might happen?, not exact , 10 stocks a day on the Naz 20?? once a week?
In your experience, can a stock lose 50% or more of it's value. Or is this a "how long is a piece of sting" type of silly question. sorry if it is.

Gardan
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Old Jan 12, 2005, 11:12pm   #13
 
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Bill Dunn once said trading was a matter of survival. Living to trade another day. Risking a max of 1% of your trading capital ensures you live to trade another day.

Traders who shoot for the moon on 25%, 50%, 100% of their trading capital get shot down by the market makers and others who saw them coming.

Apprentice floor trades have to make 30 trades a day using support and resistence and still breakeven at the end of the year (they have to make a small profit to cover costs). then they graduate !!!
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Old Jan 12, 2005, 11:17pm   #14
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techst

Gardan started this thread
Quote:
Originally Posted by techst@
Another way of looking at the 1%/2% risk per trade is by risking these small amounts your allowing enough time to reach your expectancy. If you tested your system and you were profitable 60% of the time, then your giving yourself enough time to reach that expectancy. You may well have a system that is more than 60% right but if you gunsling with your money management you may never reach those profits. Risking a small amount per trade allows you to let your edge come to the surface and lets you to ride the bumps of a early prehaps unexpected drawdown. Your edge may only be slight but tight money mangement will help us all achieve our trading goals.
techst, do you see the stop loss value as your risk or the amount of shares you purchase.When calculating your risk?
Just trying to get a consensus you understand.

Might start a poll?
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Old Jan 12, 2005, 11:18pm   #15
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Garden,

Mac is correct and although this type of event is rare it can and does happen and in my view will happen again. You only have to have one event like this happen in your trading career and it will finish you completely. I know that I will get a lot of negative views from others on here about this but to me it is never worth risking bankruptcy no matter how unlikely the event.

I cannot remember the exact details of the stock name but one of the persons concerned had bought 2000 shares of a stock that was valued at $60 (ish) so having an exposure of $120K with an account of only $30K.

The stock was then suspended from trading and when it opened up again it was trading at around $10. This meant that the loss on the trade was immediately (2000 x $60) - (2000 x $10) = 100K. Taking off the $30K account in margin, this person became liable for $70K and they had to sell their house to cover this.

This may be a rare occurence but it does happen and they way to avoid it is to ensure that you never have an account exposure greater than the size of your account. So this means if you have a $30K account then you can trade a maximum of 1500 shares on a $20 stock or a maximum of 375 shares of an $80 stock.

As a rule I trade stock prices that have a value of between $14 and $60. This is why you wont find me trading stocks like GOOG because the maximum I could trade with my account would be around 300 shares and there is little point in me trading at that low a number.


Paul
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