Proper risk or money management is the most important thing more than any trading strategy. Even if you have a strategy with an edge and the highest win rate, if you don't manage your risk well, your account will surely blow up.
Nonapplication of proper risk management is the most common reason why the bigger percentage of traders wipe out their accounts.
With risk management, we can determine the exact position size or the number of shares of stock you want to buy. There are only three ingredients to determine that: risk amount, entry price, and stop loss price.
Know Your Account Risk Percentage
Unlike on the other sites, we are not going to suggest here how many percentages of your account you should put on risk. Why? Because it all depends on YOU!
Many gurus suggest risking only 2% of your trading capital, but following this risk percentage rule blindly is like bringing the dead (your account) slowly to its final destination. Always remember that money management is dependent on both risk tolerance and trading skill, not an arbitrary percentage of your trading account.
But for example, you finally decided to risk only 2% percent of your trading account. So if you have a Php100,000 on your stock trading account, you are only going to risk Php2,000 on one trade.
Know the Trade Risk
Determining your entry price and stop loss price depends on your trading strategy. Always remember that before entering a trade, you should also know when to exit a trade. The stop loss price will tell you when it's time to close your positions if the price moves against your favor before your losses get bigger more than the amount you are willing to risk. Knowing the entry and stop loss prices will tell you the Trade Risk.
The photo below shows a trade example in ANI (AgriNurture Inc). The stock price is moving in an uptrend and you decided to make a long position at 4.40 and set your stop loss at 4.12. The difference between your entry price and stop loss price is the Trade Risk, which is 0.28.
Calculate Position Size
Now we have all the information (risk amount, entry price, and stop loss price), let's go to the last step of determining the proper position size for stock trading.
To calculate the position size, use the very simple formula below:
Account Risk (in Php) / Trade Risk (in Php) = Position Size (number of shares)
We determined on the previous steps that you are only willing to risk Php2,000 on each trade and the Trade Risk for ANI stock in 0.28, so...
Php2,000 / Php0.28 = 7,143 shares
It means that your ideal position size in trading ANI stock is 7,143 shares. But because trading of stocks in the PSE is done by Board Lot System, you can only buy 7,000 shares of ANI.
Most importantly, if the stock price moves against your favor and hit your stop loss price, you are only going to lose the amount you are willing to risk.
In trading, defense is the best offense. Protecting your trading capital should always be your priority and proper risk management through position sizing is the best way to do that.
Always remember, size does matter! 😉