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Now what if you are trading stocks with an entry and an exit point already predefined; that is where do I get in and where do I get out. That strategy might be good but that is not risk and reward. The most important question is how much am I invested and how much do I get out. What is
% of risk on each stock position in portfolio and what is risk to total portfolio. Let’s take an example. You bought 100 shares IBM @50 for $5000 in a total portfolio of $200.000. You put a sell stop loss to sell all 100 shares if IBM goes to $40 / share. That means your risk on IBM is $10 / share or $1000. But your real risk to your portfolio is .5% or $1000 divided by $200,000. If you have a sell exit point of $100 then your reward on stock would be 100% and reward to your total portfolio was 2.5%. So your total risk to reward was 5 to 1. You could crunch numbers all day to make up formulas to fit your strategy, but most important part is how much are you risking. Here are some general rules when it comes to risk: Don’t risk more than 2% on any given trade or idea. That doesn’t matter if your strategy is technical or fundamental or discretionary. Risking 1% would be safer. Most large fund managers risk much less.
Diversify. Buying 1% risk on IBM and 1% on Dell and 1% on Hewlard Packard is a 3% risk because they all sell same products Don’t risk more than 20% of your portfolio at any one time, 10% would be better. You have to have a way to quantify greed factor or it might consume you and all your money at same time.
In my own portfolios I try not to risk more than 7% on an initial portfolio position.
Initial risk and on going risk can be two different risks. As a trade becomes profitable amount of at risk at any moment in time can be a variable not a constant. That would allow for letting profits run while cutting losses short. However, making your initial risk a variable in most cases would be a disaster. Once initial risk is conceived it should never be increased. Greed may become primary factor in increasing initial risk and that is always a fast track to increasing losses.
I hope that risk and reward become primary strategy concern in your future investing and trading.
private placement fund manager, and owner of http://ww.buypanic.com, an investment newsletter. I ahve over 24 years trading experience, specializing in stock index trend following. I alos have experience in volatility based money management principles. Buypanic.com offers valuable insight on both stock strategies and money management.
