Stock Market Day Trading
Position Size - Equal Risk Method
Stock market day trading does not require an extremely complex method or system to make money. It also does not require that you have unique information or knowledge, that no one else has access to.
Stock market day trading does, however, require that you know certain basic things, such as what I am covering here ......... Position sizing, (a.k.a. trading money management).
On the previous page about position size, I covered what I call the equal dollar amount method. The equal dollar amount method is very simple and it will keep you from taking on too much risk in any one stock trade. Although simple, it is quite adequate to use.
But like it's name, the individual stock trades have an equal dollar amount, not equal risk. I'll explain using the following two charts.
This first chart is the same SBUX chart as before, except this time using equal dollar amount position sizing and buying only 350 shares with one $10,000 block (out of the $50,000 account). Note that putting an initial stop @ 27.92 risks $35 on this trade.
Now lets say you took another breakout trade that same morning with another $10,000 block and bought 90 shares of CRM @ 106.88. To exaggerate my point, lets say you placed your stop all the way down @ 104.67. The risk on this trade is $199.
Even though in this example the trade was made with the same amount of money ($10,000), the risk on this CRM trade is more than 5 times higher than the SBUX trade, because of the distance of the stop from the entry price.
An equal amount of capital used on the trade ($10,000), but over five times the risk. As you can see, the equal dollar amount method of position sizing does not equalize risk.
Stock market day trading doesn't require that you equalize risk on every trade, to get decent results, however, if you want to step up to the next level of complexity in trading money management and equalize risk across all trades, you'll probably see better results in the long run. So now lets go over determining position size as a function of risk.
POSITION SIZE - EQUAL RISK METHOD
The Equal Risk Method, sometimes called the fixed percent method determines the position size of the trade from the size of the stop (difference between the purchase price and the stop loss) on each individual trade. This method allows you to make all of your day trades with the exact same level of risk.
First, you must choose a percentage to work with across all trades. Lets say that you choose 1/2 % (very conservative) as the maximum amount that you are willing to lose on any
one trade. Since the percentage is equal or fixed across all trades, it simply comes down to this ........ the wider the stop on a trade, the less shares you can trade of the stock.
I'll show you an example. The lateral in the chart below comes up on your radar and you want to be long if it breaks out. You want to place a buy stop order @ 53.74 and your stop will be at 53.47, so the amount of risk will be $0.27 per share.
Now you need to determine how many shares to buy. You've already decided that your maximum risk for each individual trade that you make will be 1/2 % of your account size.
The maximum loss that you will allow on any one trade will be $50,000 x 1/2% = $250.
The number of shares that you can buy is 250 / .27 = 925. So as you can see, even using a very conservative 1/2 % risk, you still will be only trading one stock that day, because you'll be using almost your entire account (925 sh. x 53.74 = $49,709).
OK, let try another example, except this time using 1/4 % as the max. risk. Take a look at the chart of URBN below. You place a buy stop order @ 30.81 for the anticipated breakout and you intend to place a stop @ 30.64.
The amount that will be risked per share for the placement of this stop will be $0.17. The maximum loss that you will allow on this trade is $50,000 x 1/4 % = $125. How many shares can you buy?
The answer is 125 / .17 = 735 shares, which would be a total of $22,654. Only about half of your account size. So you could trade two stocks that morning.
As you can see it's simpler and quite conservative from a risk perspective for a smaller stock trading account to just use the other equal dollar method, rather than the equal risk method, and just divide the account into five blocks of $10,000 each. If you're reasonable about where you place your stop loss, the risk on individual trades is quite small for these types of trades.
Always keep in mind that with stock market day trading you are going to have losing streaks. There's no getting around that fact. That is the primary purpose of position sizing.....
to get you through those losing streaks, so that you can take advantage of the positive expectancy of your day trading system.
Whatever trading money management method you decide to use, spread your exposure across different stocks and whatever you do follow this important stock market day trading rule: don't trade the entire account on one stock no matter how small the account. After a really sorry run of bad luck, you want to be around to trade another day.
Remember, stock market day trading is very unforgiving to the traders that concentrate solely on their entries and exits. You've got to keep an eye on your exposure in the markets.