Risk Management
I reserve half my line in cash. Therefore, I will never lose my line.
Trading is risky. In stock ownership you are betting on the management’s ability to keep the business afloat and hopefully make a profit. Companies can and do go out of business everyday. Many businesses that were household names 20 years ago are no longer around.
By trading stocks you are starting your own business. The shares of stocks you are holding is your inventory. You are buying an asset that you can use to generate a cash flow. Consider yourself a store owner. You want to purchase the best merchandise that is in demand and that will sell quickly for the best price.
Cash is your lifeblood and it allows you to trade. If you place all of your cash into a single stock and that company goes bankrupt then your account gets wiped out. As a basic rule I keep 50% available in cash. This affords me the ability to move into another position if a rare opportunity appears.
In stock trading you a purchasing merchandise to make that available for sale. There are several strategies on how to acquire them, but at the end of the day you must sell the stock once you have bought. Selling stocks generates income that you can use to supplement your lifestyle. If you never sell then all profits are paper paradise.
I prefer a concentrated portfolio, because I know how a company is trading and know if it is in trouble. You put all of your eggs in one basket and watch the basket. I have tried to roll 20 – 30 stocks in a paper portfolio and keeping track of this many is confusing. By watching 2 or 3 at a time I have more intimate knowledge on how it’s trading.
The Daily Page assists in focusing my attention.
The famed trader Jesse Livermore recommends keeping records:
“You cannot wisely read a book on “How to keep fit” and leave the physical exercises to another. Nor can you delegate to another the task of keeping your records, …”
Smitten R. (2001) How to Trade Stocks, Jesse Livermore: His own words: The Jesse Livermore secret trading formula for understanding timing, money management, and emotional control. Page 2
McGraw-Hill. New York, NY.
ISBN0-07-14697946
The clearest moment for a trade is at the point you make it. When you enter a trade you must have an upside and a downside limit. A stop order or a limit order can be used to automate this. I keep my losses to 7% from my buy point. The quickest, easiest, and cheapest loss is taken quickly. If you are wrong, admit it, and move on to another trade that would be profitable.
When a trade doesn’t work out something is wrong. The market is wrong. The stock is wrong. The timing is wrong. Preserve your cash. You worked too hard to build it.
How do you calculate risk? I think it in terms of percentages. I limit myself to 2% per position. If I’m wrong a single setup will not wipe out my account. If I have a total of 6% loss then I stop trading for the month
For example I have 10,000 and 1% is $100 and $200 is the amount that I am risking on a single trade.
I buy 100 shares of a stock at $20.00 = $2,000
A 7% on the stock is loss is at $18.60 = $140.oo
This would fit within my trading boundary