Maximum risk for stock purchases

[pb]

For leveraged products (futures, stocks on margin, CFD, SB,...) the consensus seems to be that the maximum risk on a trade should be in the region of 1% to 2%, preferably even less. There is a huge amount of discussion on this, including thick books.

What's the consensus on the maximum risk taken while purchasing stocks by cash? How much initial risk would you take on your, let's say, ISA or SIPP account?

Of course it depends on your risk tolerance, but surely there are some age-old Wall Street saying on this as well?

 

[pb]

27 views but no replies. C'me on guys, surely it's not an absolutely stupid question?

Ah well, I can only bump it up to the top of the forum listing.

 

[Racer]

How much can you afford to lose?
Also depends on the share.. BARC is surely not high risk (but not without some of course) compared to AIM shares.
What is your time scale.. daytrade or longterm? Different risk factors would apply.

http://www.riskgrades.com/

 

[SOCRATES]

You are not getting the answers to the information you seek because you are asking the question back to front. This is not helpful when placed in front of members, many who are already baffled by the variety and complexity of questions asked on many topics, that get cris crossed with lots of opinions.

What you obviously are seeking is a view or views.

It would be helpful if you were to define your question in terms of proportional exposure and in terms of stop loss limitations, then, this might overcome the inertia you are confronted by at this stage.

 

[Racer]

Also look at this for FTSE shares, you can select for risk grade as well

http://www.digitallook.com/cgi-bin/digital/heatmap.cgi?

 

[pb]

Thanks Racer. The timeframe is between 1-3 months on our ISA accounts.

Socrates, not sure I understand your point entirely, but I'll try to answer anyway.

Here is an example.
Account size = £10,000
Maximum initial risk allowed, let's say 2%.
Buy price = 150p
Stop loss = 135p (nearest support)
All the above are fixed, the number of shares is variable. The number works out to 1130.
Total risk is therefore = 1130 * (15p) + £29.5 in expenses (commissions + stamp duty)
=
£199
= 1.99% of £10,000

So now the question is: Is 2% too catious for cash products? I don't usually calculate total exposure because I place hard stop losses in the market. Should I?

 

[SOCRATES]

I see what you are doing and it is an interesting concept because you are factoring in the expenses into the risk percentage, which makes the stop loss tolerance even more tight. I do not do that but consider all dealing costs as running expenses, and the stop level is dealt with separately.

I do not consider it to be too cautious, I consider it prudent. Being prudent is more important than being cautious. This is because if you are too cautious by nature, often this can seriously prevent you from taking advantage of opportunities.

On the other side of the coin also if you calculate your total exposure (absolute total exposure) this can also have an effect you do not expect.

It brings to mind an occasion when I was running a big position and in the middle of this, a friend arrived.
As he was a friend, I made the error of allowing him to invade my trading environment by allowing him to sit beside me as the move progressed.

He then ventured casually to ask if I had calculated my exposure. I took my calculator and worked it out.
I instantly succeeded to frighten myself silly. It made me so nervous that I closed my position immediately.
The trend then continued intact for the rest of the day.

In this there are two lessons I learnt.

1. Never succumb to calculating the total absolute exposure either before, during or after the trade.

2. Never allow visitors into the trading environment when holding a position.

In consequence of this experience, I work behind locked doors. I do not allow visitors. There is a red light outside that goes on when a live trade is in progress. This is a warning that I must not be disturbed under any circumstances except in an emergency.

I have found this to be a perfect solution to the problem.

 

[pb]

Good response Socrates. Thanks.

I see what you are doing and it is an interesting concept because you are factoring in the expenses into the risk percentage, which makes the stop loss tolerance even more tight.

Did you mean 'stop loss tolerance' or 'position size'? The stop loss doesnt depend on the calculation of risk. The number of shares bought does.

 

[roguetrader]

To my mind your question essentially answers itself, the risk you speak of essentially boils down to how muuch money you are prepared to lose if you are wrong, why should this change because the product is leveraged. You are prepared to lose what you are prepared to lose in the worst case senario, I really don't see why you should be prpared to lose more or less because your product is leveraged or not.

 

[pb]

RT,
Thanks. That's exactly what I was trying to find out: should my risk tolerance change because the product is cash, not geared. Your answer makes sense to me.

 

[SOCRATES]

Good response Socrates. Thanks.



Did you mean 'stop loss tolerance' or 'position size'? The stop loss doesnt depend on the calculation of risk. The number of shares bought does.

I have a view on this.

My view is that the number of shares bought is irrelevant.

What is relevant is whether they are bought into a potential rise, the stronger the rise, the better.

Then if this is the case, the choice of entry point and timing the entry is crucial in order to establish a position as a strong holder, not otherwise.

In this regard, the stronger the holding as a consequence of correctly timed execution,
the less the propensity for the stop, correctly and tightly placed, to be hit.

Therefore the object of the excercise is that where risk exists, the correct tactic should be employed to minimise this risk, and not to go looking for it just because it is there.

In this, placing a tight stop loss is directly linked to entry point, timing and execution, and not to position size.

This is because a position taken has to be very heavy for it to disturb the market.

The stronger the market the less turbulence a very heavy position will cause to the progression of that price.

This is why entry, timing and execution are crucial. The risk element is secondary. The level at which the stop is placed is tertiary.

 

[SOCRATES]

To my mind your question essentially answers itself, the risk you speak of essentially boils down to how muuch money you are prepared to lose if you are wrong, why should this change because the product is leveraged. You are prepared to lose what you are prepared to lose in the worst case senario, I really don't see why you should be prpared to lose more or less because your product is leveraged or not.

Roguetrader, I have a view on what you say, which is in two parts in one.

Firstly, you are percieving this from the point of view of money. In my view, percieving trading through the point of view of money (and I have covered all of this elsewhere extensively) is not the best way to deal with a game situation involving some tactical decisions dependent upon conditions of uncertainty, but better to think of the monetary aspect as negotiable value coupons or just a score of points, as if they were just good marks when you get it right and bad marks when you get it wrong.

The object of the excercise is to get it right many more times than you get it wrong and to use tight stops always to mitigate and minimise losses against gains overall.

The implications of leverage are obvious and do not need explaining again.

 

[roguetrader]

Socrates, I agree with you on the principle that trading should not be viewed from the perspective of money, essentially money impacts most of our lives to such an extent that the perception of making or losing of it cannot be done without emotion. This like any other emotion in trading is a negative and should be avoided, to wit I do not even monitor p&l during the trading day. However I believe that it would be irresponsible in the extreme for most traders not to calculate how much money they stand to lose. One of the most basic rules of risk management is not to risk more than you can afford to lose. If you do not work out how much you can lose before hand you are ill equipped to satisfy this rule. After that consideration it should be all about the trade, correct management and exit, the money will take care of itself.

Indeed the implications of leverage are obvious which is why they should not be used to impact the stop, leverage does not belong to th trader so he should not accept it as a percentage of his loss.

 

[SOCRATES]

Socrates, I agree with you on the principle that trading should not be viewed from the perspective of money, essentially money impacts most of our lives to such an extent that the perception of making or losing of it cannot be done without emotion. This like any other emotion in trading is a negative and should be avoided, to wit I do not even monitor p&l during the trading day. However I believe that it would be irresponsible in the extreme for most traders not to calculate how much money they stand to lose. One of the most basic rules of risk management is not to risk more than you can afford to lose. If you do not work out how much you can lose before hand you are ill equipped to satisfy this rule. After that consideration it should be all about the trade, correct management and exit, the money will take care of itself.

Indeed the implications of leverage are obvious which is why they should not be used to impact the stop, leverage does not belong to th trader so he should not accept it as a percentage of his loss.

I agree with the viewpoint you express above which is the correct one.

However, additionally, you would be shocked and horrified at the stupidity of which some people are capable of when presented with a scenario with potential without limit provided they respect the rules of engagement imposed upon all of us.

Some individuals consider they are above this, and indeed above you and me and everybody else and consider, for some reason best known to them despite repeated and heated warnings they are immune from the very dangers you point out as a consequence of dereliction of diligence, of personal responsibility, of morals, and of conduct.

Many of the facts with regard to these are horrifying, some truly comical, some pitiful.

These facts are all provable without question because I have them documented in my archives in detail, with irrefutable supportable evidence alongside to support all of it.

I may have a paddy from time to time and burn books, but my archives remain intact, and go back 40 years plus.

I have for a long time considered starting a thread about it all, in allegorical form.

You would all then find out who's really who in the zoo, so to speak.

I assure you and all the membership, and the moderators and the owner of this website,
it would constitute the most sobering, the most horrific and the most revealing material ever to be made available in this way.

I have not done it not because I cannot, but because I choose not to, as my posture remains benign despite the occasional prodding.

 

[roguetrader]

In truth it is my humble opinion that the vast amount of wouldbe traders who fail were, if they only knew it doomed to fail before thay ever traded a single position. From what I have seen an individuals approach is the single most important aspect of the trading game. If it's all about money, then I am afraid the individual is doomed to failure. For me the monetary risk has its place in the preliminary assessment but after that It must be, absolutely has to be, all about the trade.

 

[SOCRATES]

In truth it is my humble opinion that the vast amount of wouldbe traders who fail were, if they only knew it doomed to fail before thay ever traded a single position. From what I have seen an individuals approach is the single most important aspect of the trading game. If it's all about money, then I am afraid the individual is doomed to failure. For me the monetary risk has its place in the preliminary assessment but after that It must be, absolutely has to be, all about the trade.

I do not disagree with you in principle only that I place the quality of prospect for the trade first, and then everything else to follow.

 

[roguetrader]

A fair point.