Hey there fellow traders!
So, picture this: my buddy calls me up in a panic because he’s been playing the options game for a couple of years, thinking he’s the next big gun. But guess what? In just two weeks, he managed to flush 40% of his trading capital down the toilet while he was up 60% on the original capital before that! How’s that for a plot twist?
Now, here’s the kicker: turns out, this guy never heard of a stop loss. He was all about that Martingale strategy, doubling down every time things went south. And you know what they say about doubling down without a parachute? It’s a one-way ticket to Brokesville! I just couldn’t believe how he survived these 2 years without any stop loss.
But get this—when I asked him why he didn’t try the ol’ Martingale magic again, he hits me with the classic line: “Sorry, bro, wallet’s on empty!” No more funds for our fearless trader.
So, I tried to cheer him up, you know, being a good pal and all. “Hey, at least you’ve got your original capital intact and two years of trading experience,” I said. But then he drops the bombshell: He said he had also borrowed some funds from someone before the last series of Martingales and is almost down to 0 now. Really?? (Now I knew why he had called but come on, I am not going to lend him any money for further trading).
These stories I am sure will be across everywhere but the point is if the risk is not managed, it’s just a matter of time before one’s account goes bust. I am sharing here what I do to manage my risk.
Suppose one has a trading capital of 10 lakhs, no matter what, I am not going to risk more than 1% of my overall capital on a single trade (which would be Rs 10,000 per trade). If I see an opportunity where my loss per share or lot is going to be more than Rs 10,000, I am going to wait for a better price or pass on the trade as all I care about is preserving my trading capital.
For example, if the LTP of a stock is Rs 200 and my SL is 190, I am not going to buy more than 1000 shares (Rs 10 * 1000 = 10000). So I would enter this trade only with a capital of Rs 2 lakhs.
But consider this scenario: if the stock price is at Rs 2000 and my stop loss is at Rs 1990, that’s still just a Rs 10 difference per share. However, given my limited funds of only 10 lakhs, buying 1000 shares would require Rs 20 lakhs—double of what I have. So, instead of risking it all on one trade by buying 500 shares and tying up my entire capital, I might opt for a more conservative approach. Perhaps I’d consider purchasing only 200 or 250 shares. It’s about striking a balance between risk and opportunity, ensuring I have the liquidity to seize other chances while still in the midst of a trade.
Furthermore, suppose I’m engaged in several trades simultaneously; I ensure that I never jeopardize more than 10% (Rs 1 lakh) of my total capital at any given moment. For instance, if I’m risking 0.75% in one trade and 0.5% in another and so on, and I’ve embarked on a total of 15 trades, with the cumulative risk hovering around 1 lakh, I refrain from deploying any additional funds if there’s still some left in reserve.
Now, consider this: imagine if all 15 of my trades hit their stop losses, resulting in a loss of 10% of my trading capital. While it’s rare for all trades to tank simultaneously, let’s entertain the possibility. In such a scenario, I stick to my plan and swiftly exit those trades. Then, I withdraw the remaining 9 lakhs to my bank account. After that, I’ll take a breather from trading for a month or two, using the time to reflect on what went awry and how to course correct for the future.
I strongly encourage you all to dive into the final two chapters of Mark Minervini’s ‘Trade Like A Stock Market Wizard.’ There, he delves into the crucial topic of risk management, emphasizing that losing a small portion of your capital won’t necessarily boot you out of the markets. However, if you lose a substantial chunk of your initial capital, well, you might be in for some rough waters ahead.
Consider this: if you’ve lost 10% of your capital, you’ll need to make roughly 11% return on the remaining funds to break even—a challenging but achievable feat. However, if you’ve suffered a hefty 40% loss, you’ll be facing an uphill battle, needing to generate a whopping 66.67% return on what’s left just to get back to square one.
In trading, losses are inevitable. But here’s the deal: if you keep those losses small, you’ll still be standing when the dust settles. It’s a bit like navigating a treacherous sea—if you can steer clear of the big waves, you’ll keep your boat afloat. However, if you let those losses swell into titans, well, let’s just say the outcome won’t be pretty. So, remember: in the world of trading, size matters. Keep your losses small, and you’ll keep your head above water.
Returning to the essence of this discussion, it’s crucial to recognize that while risk management is just one component of trading, it serves as a lifeline for your account, regardless of whether your trading strategy(Martingale for my dear friend) boasts a positive expectancy or not.
As for my friend is concerned, he’s still reaching out to other friends, hoping to borrow a few bucks while boasting about his skills as an options writer. Looks like he’s not giving up on his trading ambitions anytime soon!
Let me know how you guys manage your risk so that we all can learn from each other…
Take care guys and Ciao Adios…
