Proper risk management and size calculation
Break-even math: How much gain is needed to recover from a loss fully?
Congratulations on taking your first steps into the exciting world of trading! Before we dive into the nuts and bolts of risk management and preventing those dreaded big losses, let's take a moment to appreciate the journey you're on your future self will thank you.
Trading is like a rollercoaster ride - thrilling, unpredictable, and sometimes a little scary. But fear not, my friend Immaculate is here! With the right tools and a dash of not taken life so serious, we'll navigate these choppy waters together a band of living souls.
Now, let's talk about the most crucial aspect of trading: preventing those colossal, life-altering losses. You know, the kind that can make you question your life choices and wonder if you should have stuck to collecting stamps instead, selling coupons from amazon.
Think about it: in life, we all know someone who didn't prevent a big loss - a relationship gone sour, a business venture gone wrong, or a haircut that made them look like they lost a bet with a lawnmower. It's the same principle in trading. If you don't manage your risk, you risk losing it all.
So, how do we prevent these big losses and stay in the game? It's all about calculating your risk size. Don't worry, I won't bore you with complex formulas and jargon. Instead, let's break it down into simple, easy-to-digest steps.
Alright, buckle up, because we're about to dive into the thrilling world of trading strategies!
So, you're wondering about the difference between trading a balance based on percentage per trade versus fixed lot size. It's like choosing between a buffet and a prix fix menu, both have their perks, but one might leave you feeling more satisfied (or broke) than the other.
Percentage per trade
Imagine you're a daredevil on a rollercoaster. The higher the percentage of your account you're willing to risk per trade, the steeper the drops and the bigger the thrills. This method is like riding a rollercoaster blindfolded – you never know how big the next drop will be.
Pros:
* You'll never risk too much on a single trade, which can help protect your account from massive losses.
* As your account grows, so does the amount you risk per trade, potentially leading to bigger gains.
* It's like a built-in safety net, ensuring you don't go all-in on a single trade and lose everything.
Cons:
* You might not be able to take advantage of big opportunities if your percentage is too conservative.
* It can be tough to stick to the plan when the market is going crazy – you might be tempted to risk more than you should.
* It's like trying to drive a car with the brakes on – you might not get anywhere fast.
Fixed lot size
This one's for the control freaks out there…. you know who you are! With a fixed lot size, you're like a chef cooking with precision – you know exactly how much of each ingredient you're using.
Pros:
* You'll always know exactly how much you're risking on each trade, which can help you sleep at night.
* It's like having a set recipe – you know what to expect every time you cook.
* You can take advantage of big opportunities without worrying about risking too much.
Cons:
* If your account grows, you might not be able to take advantage of the increased buying power.
* If your account shrinks, you might be risking too much on each trade.
* It's like trying to fit a square peg into a round hole – it might work for a while, but eventually, something's gotta give.
So, which is better for portfolio growth?
It's like asking which is better, chocolate or vanilla – it depends on your taste!
If you're a risk-averse investor who wants to protect your account and grow it slowly but surely, percentage per trade might be the way to go.
If you're a risk-taker who wants to capitalize on big opportunities and potentially grow your account faster, fixed lot size might be your jam.
Just remember, there's no one-size-fits-all answer – it's all about finding the strategy that works best for you and your goals.
Determine your risk tolerance
Are you a daredevil who thrives on adrenaline, or do you prefer a more cautious approach? Knowing your risk tolerance will help you set realistic goals and manage your emotions during those inevitable ups and downs.
The most common lot size for trading is indeed 1-2% of your account size. But before you dive into the deep end of the trading pool, you gotta know your account size like the back of your hand. It's like trying to bake a cake without knowing how many eggs(find an alternative btw) you have.
Once you've got your account size locked down, it's time to decide how much of your precious capital you're willing to risk. Are you feeling bold and ready to risk 2%? Or are you more of a cautious trader, sticking to a 1% risk?
Remember, the lot size you choose is like a lever that can magnify your profits or losses. So, choose wisely.
Set your stop-loss: Think of a stop-loss as your safety net. It's the price at which you'll cut your losses and exit a trade if things don't go according to plan. A well-placed stop-loss can be the difference between a minor setback and a major catastrophe. In TYCA I go over using the PSAR indicator for your stop loss because I want to make sure that your capital is protected at lest know how… if you decide to do something else that’s fine as well just protect you assets.
Monitor your risk-reward ratio
This is the ratio of the potential profit to the potential loss on a trade. Ideally, you want to aim for a risk-reward ratio of at least 1:2, meaning you're risking $1 to potentially gain $2. This helps ensure that your winners outpace your losers in the long run.
Now that we've covered the basics of preventing big losses, it's time to put these principles into practice. Remember, trading is a journey, not a destination. With a little patience, a lot of discipline, and a healthy dose of humor, you'll be well on your way to success.
So, strap in, my friend, and get ready for the ride of your life! The first thing you must know is your risk about and tolerance of trading account.
Let's say your friend Thoth has an account size of $10,000 in equity. Thoth wants to take a trade at a 2% risk on a single trade, which means risking $200.
To calculate the lot size, you can use the formula:
Lot size = Account Equity x Risk Percentage / Dollar Amount
Plugging in the numbers:
Lot size = $10,000 x 0.02 / $200
Lot size = $200 / $200
Lot size = 1
So, in this example, Thoth would trade with a lot size of 1.
Why is this even important?
Great question! Managing your risk should be the #1 priority if you want to become a long-term profitable trader. By determining your risk amount, you can calculate your position size and then follow your trading plan with precision.
Remember, discipline and consistency are key. Stick to your plan, manage your risk, and don't let emotions get the best of you. With time and practice, you'll be well on your way to becoming a successful trader. 📈
How to determine your risk amount
Determining the risk amount in trading is a crucial step in managing your trades effectively. Here's a step-by-step guide to help you determine your risk amount:
1. Define Your Risk Tolerance: Before you start trading, you need to know how much you're willing to lose on a single trade. This is your risk tolerance. It's usually a percentage of your total trading capital. For example, you might decide to risk 2% of your account on a single trade.
2. Calculate Your Risk Amount: Once you've defined your risk tolerance, you can calculate your risk amount. If your risk tolerance is 2% and your trading account has $10,000, your risk amount would be:
Risk Amount = Account Size x Risk Tolerance
Risk Amount = $10,000 x 0.02
Risk Amount = $200
So, you would be willing to risk $200 on a single trade.
3. Set Your Stop Loss: A stop loss is an order that automatically closes your trade when the market reaches a certain price. This helps you limit your losses if the market moves against you. Your stop loss should be set at a level where you're comfortable losing the risk amount you've calculated.
4. Determine Position Size: Your position size is the number of shares, contracts, or lots you buy in a trade. It's calculated based on your risk amount and the distance to your stop loss.
Position Size = Risk Amount / Distance to Stop Loss
Recovering from a loss in the stock market is like trying to climb out of a well after you've fallen in. It's not a walk in the park, let me tell ya!
Let's break it down with some numbers, shall we? To recover from a 10% loss, you need an 11% gain. Easy peasy, right? But if you lose 50% of your investment, you'll need a whopping 100% gain to break even. Talk about a uphill battle!
And don't even get me started on the bear market of 2007-2009. The S&P 500® Index lost about 55% of its value. Ouch! To break even, investors needed an approximate gain of 123%. That's like trying to climb Mount Everest with a broken leg!
Understanding the importance of recovery time, or the number of months potentially needed to break even, can help investors make informed decisions on asset allocation and risk management. It's like having a crystal ball that shows you how long it might take to recover from a loss.
Print this out and put it in front of your computer…
A simple example shows this.
$1,000 = starting value
$ 900 = $1,000 - (10% of $1,000), a drop of 10%
$ 990 = $ 900 + (10% of $900), followed by a gain of 10%
The ending value of $990 is less than the starting value of $1,000.
Knowing the percentage return is vital for comparing different investments.
A $20 gain on a $100 investment is a 20% increase, but the same $20 gain on a $200 investment is just a 10% increase. It's like going from a small house to a mansion and still only getting a 10% discount on your shopping. Not as impressive, right?
So, when evaluating different investment opportunities, especially in diversified portfolios, it's crucial to make this comparison. Don't be fooled by the absolute gain numbers, my friend. Always look at the percentage increase to get a true sense of the investment's performance.
And with that, I bid you farewell(lol) for this newsletter. Stay tuned for more insights and financial wisdom in the next edition!