Position Size & Risk. Help! I'm confused....

This is a discussion on Position Size & Risk. Help! I'm confused.... within the Swing & Position Trading forums, part of the Methods category; I have a question about position sizing and investment risk. I understand that a 2% risk on a $10,000 portfolio ...

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Old Jun 9, 2011, 2:52am   #1
Joined Jun 2011
Position Size & Risk. Help! I'm confused....

I have a question about position sizing and investment risk. I understand that a 2% risk on a $10,000 portfolio would be $200. But what if I only want to invest $5,000 (half) of my portfolio in one stock and keep the other $5000 in cash? Is my 2% risk now just $100 ($5000 x 2% = 100) or is my 2% risk still based on the original overall size of my portfolio ($10,000 x 2% = $200) even though I am only presently only investing $5000 into one stock position.

I am currently reading both Elder and Link's books and they seem to contradict one another on this issue. Elder seems to say that your 2% risk is always based on your entire portfolio of $10,000 (cash, open stock positions, everything in your trading account basically) no matter the size of the trade -- so $10,000 x 2% = 200. Link advocates leaving half your portfolio in cash ($5,000) and only investing the remaining cash ($5,000 - your at risk capital) - and then proceeds to take 2% of this amount -- $5,000 x 2% = 100).....so I'm confused. Is my risk on $5,000 dollars $200 or $100.......

I have done a lot of wonky reading on this subject, but I still need some clarification. Thanks!
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Old Jun 9, 2011, 4:49am   #2
 
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Re: Position Size & Risk. Help! I'm confused....

I would say… especially in your case, as someone who is just starting out… trade with whatever risk level you are comfortable with. If you can stomach losing $200, and not lose sleep over it, then possibly 2% is right for you. A 2% limit will (pardon me… "may") keep you from blowing out your account in short order. I've read Dr. Elder, and believe the 2% rule to be sound advice, but this is an arbitrary number. Possibly, as someone new to trading, you should be trading at 1% or even .5% until you get a feel for things and know where your personal risk tolerance is at. I've known traders who have had problems with trading at 2% and backed down to 1% and found success… less pressure, better thought process, and more money at the end of the week.

The first year or so of trading is about survival; capital preservation over capital appreciation. Learn some skills and be patient… the making money part will (pardon me… "may") follow.
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Old Jun 9, 2011, 7:00am   #3
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Re: Position Size & Risk. Help! I'm confused....

Scrittitrader started this thread Thanks Jpennybags - I get the 1%, 2% arbitrary part - but I still can't seem to get the answer I'm seeking on-line, nor from the books I''m reading - Is my risk calculated by my entire portfolio (every last stinkin dollar) no matter what stock position size I am taking (say my entire $10,000 portfolio x 2% = $200), or is my risk calculated on just the smaller cash amount that I am thinking about investing in one trade (say $5,000 x 2% = 100)? Elder seems to indicate the correct answer is it's $200 everytime....is that right?
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Old Jun 9, 2011, 2:03pm   #4
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Re: Position Size & Risk. Help! I'm confused....

What it really comes down to is that Elder is saying risk 2% of your account value and Link is saying risk 1%. That's the bottom line. Don't try to read any more into it than that. As jpennybags said, which level is best is something you have to determine for yourself. Generally, the best idea is to start off smaller and maybe work higher as you develop and become more comfortable.
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Old Jun 9, 2011, 2:34pm   #5
 
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Re: Position Size & Risk. Help! I'm confused....

If you are following the money management rules offered by Dr. Elder then the 2% limit for a single trade would be calculated against your entire account (every dollar). The other facet of his rules would be the 6% rule. This rule states that you can not have more than 6% risk across your entire portfolio at any given time.

As an example: 3 open trades of 2,000 each

risk for each trade = 200
total cash investment = 6,000
total risk against your entire account = 600

If you have a current account value of 10,000 this would leave you with 4,000 of cash to invest. In accord with the rule, you would not be able to invest that 4,000 until you have reduced the risk against your account either by taking profits or moving your stop loss point. If you should lose on all 3 trades you will have hit your loss limit of 6% and must stop trading for the rest of the month (use the time off to consider your methods). Your account value would then be 9,400 which would reduce the amount of risk you can have on any single trade to 188.

I'm not familiar with the money management rules of the other author that you mentioned. Whichever method you choose, the idea is to limit the damage that you can do to your account… live to fight another day. I would not go so far as to state one method is "right".
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Old Jun 9, 2011, 6:08pm   #6
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Re: Position Size & Risk. Help! I'm confused....

10K hardly qualifies nowadays as a trading account one could apply any reasonable risk and money management to. This starts at 50K IMO unless you deal with forex micro lots. You cannot make any money trading 10K and applying a 2% or 6% rule. It is a waste of time. On the other hand, if you do not apply some reasonable rule, you will lose it all fast.

I know many will not agree but again 95% of traders lose.
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Old Jun 10, 2011, 4:14am   #7
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Re: Position Size & Risk. Help! I'm confused....

Scrittitrader started this thread Thanks all for clearing up the muckity muck - I seem to be on the right path. And no worries, $10,000 is just a hypothetical number for mathematical finesse. But I do appreciate the word of warning. And I'll be careful not to interchange the words "investing" and "trading" as I move forward on my learning curve. Off I go into the wild blue yonder.....I'm sure I'll have more questions soon.
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Old Jun 10, 2011, 8:39am   #8
 
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Originally Posted by intradaybill View Post
10K hardly qualifies nowadays as a trading account one could apply any reasonable risk and money management to. This starts at 50K IMO unless you deal with forex micro lots. You cannot make any money trading 10K and applying a 2% or 6% rule. It is a waste of time. On the other hand, if you do not apply some reasonable rule, you will lose it all fast.

I know many will not agree but again 95% of traders lose.
I don't mean to come across negatively but your statement is a load of poop because there is an experience factor you haven't mentioned. Client statistics that brokers in the USA are legally required to disclose show a band of successful traders with an average of 20% being successful with some brokers showing as much as 40%. Now that number on its own lacks context because success comes with experience. My personal thoughts about the data is that the band of successful traders are the ones that have survived countless beatings to learn how to make money.
To just say that 95% fail isn't correct. It could even be argued that 100% fail in their first 6 months but that number does drop although there isn't any data to show how long on average it can take someone to stop losing money.
Personally it took me several years before i managed to stop losing enough to warrant capital injections. It took me 2 years thereafter to start growing my account. But this is me and I am just one trader amongst many with different stories.

I am a forex trader and your statement about 2% not making an money in this Market isn't correct however it may be in other markets because of various requirements and restrictions. If for argument sake, the maximum amount of money you're willing to lose on a 10k account is 2% or 200. If your stop is 50 points away you could open a position for 4 micro lots a point. If your trade goes 100 points as it often does in forex then you looking at a 4% gain in your account. If you successfully manage 4 of those a month you looking at increasing your account with a 1k notch. That might seem like peanuts to the more experienced guys but if you maintain a good winning average over a period of years you looking at an income that's far above the average highly skilled job. I'll take that over a job any day of the week as I am sure most would.
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Old Jun 10, 2011, 3:28pm   #9
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Re: Position Size & Risk. Help! I'm confused....

Scrittitrader started this thread Thanks to everyone for staying on task and focusing on my original question (!)- who has time for 95% tangents anyway? Your advice has been very helpful - I have been reading a bit more about swing trading strategies and found this link specifically on money management -- see http://www.swing-trade-stocks.com/money-management.html - really good website for us newbies. Cheers!
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Old Jun 10, 2011, 8:52pm   #10
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Re: Position Size & Risk. Help! I'm confused....

Quote:
Originally Posted by forker View Post
That might seem like peanuts to the more experienced guys but if you maintain a good winning average over a period of years you looking at an income that's far above the average highly skilled job. I'll take that over a job any day of the week as I am sure most would.
I noticed the if in your statement.
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