"Risk No More Than 2-5%"...What Does That Mean?

[JLJ 10]

Everyone seems to agree you should not risk more than 2% (absolute 5% max) on a single trade. But what does that mean? Does it mean no more than 2% of your account should be spent on one buy? Or - that you should calculate and set your stop loss relative to the number of shares you buy, so if it goes south the max you can lose is 2%? If the latter, that allows you a much greater position size re: the number of shares you can safely buy.

[markl67 10]

The way I understand it is, if the trade goes south, the loss amount should not exceed 2% of your trading capital. i.e. $20,000 x 2% = $400.

[brownsfan019 17]

Mark has it.

 

When I was actively swing trading stocks, that is exactly what I would do. Figure out my entry, where my stop would be and then I could calculate how many shares to purchase.

[TheDude 10]

Everyone seems to agree you should not risk more than 2% (absolute 5% max) on a single trade.

 

Indeed they do. Also of note is that most lose trying to trade. What does that tell you? Whats magic about 2%?

 

Risk should be defined by your system, your comfort level, your probability of win etc.

 

That figure could be 1%, 0.5%, 10%, maybe 2%.

 

I'd ignore most of what passes for common wisdom in retail trading if I were you and figure out what suits you, not what some failed trader turned author thinks.

[JLJ 10]

Looks like my question was not clear. If my account has $10,000, 2% of that is $200. Let's say I'm looking at a stock that's $50 a share. If I want to risk no more than 2% does that mean I should buy no more than 4 shares? But let's say I set my stop loss at $49.95 (not that I would set it so close, it's just a simple example). Then to guarantee a loss no greater than $200, I could buy 4,000 shares.

Which is right?

[SIUYA 11]

the second option.

think of it as different questions.

How much am I willing to loose (not necessarily risk) if I buy this and then it goes down and I stop myself out?

2% of the equity or $200.

How many shares then can I buy if my stop is 49.95?

4000 shares.

What then is my total exposure?

[brownsfan019 17]

Looks like my question was not clear. If my account has $10,000, 2% of that is $200. Let's say I'm looking at a stock that's $50 a share. If I want to risk no more than 2% does that mean I should buy no more than 4 shares? But let's say I set my stop loss at $49.95 (not that I would set it so close, it's just a simple example). Then to guarantee a loss no greater than $200, I could buy 4,000 shares.

Which is right?

 

Your 2nd option is correct ASSUMING your stop loss is triggered where you think it will be... in stocks, gaps can crush your stop in a heartbeat.

 

Here's a random example I found from PCLN - let's sat you shorted the close where my arrow is @ 225.39. You place your stop on the high @ 236.88. Theoretical risk is 11.49/sh. The next day opens @ 241.75 = 4.87/sh higher than your stop.

 

So keep that in mind. Your 2nd option is the way I did it while swing trading stocks you just have to realize that your stop can get blown by on gaps.

[Akuma99 10]

As others have mentioned, the figure is not as important as to how the amount you choose makes you feel in your loins. Personally, I trade full time with a 1% risk (as per your second option), as anything over that and I start get itchy, irritable and glued to the screen. That said to me either I need to go to the chemist, or I am trading a risk level my energy levels are not comfortable with.

 

I trade currencies primarily where gaps aren't as common (excluding weekends), but brownsfan019 is something to think about. Larry Williams is a good one to read up on for this kind of thing.

[BlowFish 10]

Others have eluded to the key metric which is actually risk of ruin. The 2% is an OK rule of thumb that people advise to prevent a streak of losers from putting you too far underwater. Check out TradersCALM - risk of ruin menu for how and why you might want to know RoR. It varies significantly depending on the characteristics of your approach.