T2W Trading Community

Money Management Example

Calculating The Dollar Amount Of Two Percent Risk:

Trading Account Equity: $ 25,000
2% of $ 25,000 (Trading Account Equity) = $ 500
Assuming no slippage in this example

Thus on any given trade you should risk no more than $500 net which includes commission and slippage.

Actual Example In The Market Place:

MSFT is currently trading at $60.00 per share
Round trip commission is $ 80.00

Our trading system says to go long now at $ 60.00 per share. Our initial stop loss is at $ 58.50 and the difference between our entry at $ 60.00 and our initial stop loss at $58.50 is $ 1.50 per share.

Now the question is how many shares ("Trade Size") can we buy when our risk is $ 1.50 per share and our two percent account risk is $ 500.00?

The answer is:

1. $ 500.00 minus $ 80.00 (commissions) = $ 420.00
2. $ 420.00 divided by $ 1.50 (initial stop loss amount) = 280 shares

That means you should buy no more than 280 shares of the stock MSFT to maintain proper risk control and obey the 2% risk rule. If you trade future contracts or option contracts, you calculate your position size the same way. Note that your "Trade Size" may be capped by the margin allowances for futures traders and for stock traders.

Note that MSFT which is Microsoft is a technology company in the technology sector. It is important that if you want to take another trade while you are still in the Microsoft trade, that you trade a different sector of the market. This same rule applies to options and futures as well. In futures trade a different commodity. So, basically using these rules you will be automatically diversified.

Also note that if your risk in one sector is only one percent, you may take additional trades in that sector until you reach a total of two percent. You should not exceed six percent overall between all sectors. In other words, the most or total account portfolio risk you should have at any given time should not exceed six percent. Remember the two percent risk must include commissions and if possible slippage, if you can determine that. Using this technique will also keep your trade and risk in proportion to your trading account size at all times.

If you do not add-on to a current position, but your stop moves up along with your trade, then you are locking in profits. When you lock in profits with a new trailing stop, your risk on this profitable trade is no longer 2%. Thus, you may now trade another market. So, multiple positions can be possible.