September 13, 2014

Question on Risk management/ Money management

I understand from your blog that risk per trade should be limited to 1% of capital. So if I have Rs.500000 to invest, my risk per trade would be Rs.5000. Suppose the Last close of a stock is Rs 100 and SL is at 90 (10%), the no. of shares I should limit to is 5000 / (100-90) which is 500 valued at Rs. 50000.

What is your advice regarding limiting investment per stock to certain %age of total of capital, say 2%, on,  or should it be decided by number of max positions one should keep. Suppose, I am not comfortable with more than 20 open positions at a time. This will limit my investment to 500000/20 i.e. Rs.25000 investment per stock. What are your views on limit of investment per stock, if one is keeping aside Rs. 5 lac capital for shares. And what will be investment limit per stock if the capital is Rs. 10 Lac.



You can limit investment per stock to 5% of trading capital... it does not matter whether your capital is 1L or 20L.

With this, you can manage 20 positions and this is how your risk per trade will look like.
- If your average SL is 5%, then your risk per trade will be 0.25% of your trading capital.
- If your average SL is 10%, then your risk per trade will be 0.50% of your trading capital.
- If your average SL is 20%, then your risk per trade will be 1% of your trading capital.

The equation is simple.... risk per trade = investment per stock * average SL

Here investment per stock and average SL is in percentages.

Managing a number of positions requires some skills or dealing with comfort levels and will vary from person to person. For eg. I am holding long position in 65-70 stocks but it does not bother me at all. The reason is my risk per trade is less than 0.2%  and this means I can look at a market once in 2-3 days and not get sleepless nights (I rarely check the stock prices intraday except when placing new orders).

In addition, I have been able to automate a large amount of my processes so at the end-of-the-day it does not take more than 15 minutes to figure out whether to exit a trade or not (from 60 positions). This may not be possible with everyone as you need a good software and more importantly, some good programming skills.

A disadvantage of the above approach (super low risk per trade) is that your overall returns can drop if a large amount of capital remains unemployed. Say your capacity is for 50 open positions but you get only 5 investment opportunities in a year then it means I am investing only 10% of my capital whereas someone who is relatively more aggressive may have invested 25% of his capital (20 stocks).

In a non mathematical way, the answer can be put differently.... take a position of such a size that you can sleep peacefully and not be worried if you cannot see the market for 2 days. For most people, this might mean taking a position in 20-30 stocks.

If you are constantly worried about your trades then something is seriously wrong with the way you are trading.

Hope this helps.

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