Traders often ask: how they can calculate their intended risk on capital? Here are the basic steps on how to do this with an example.
Traders often ask: how they can calculate their intended risk on capital? Stop loss is a great asset in minimizing one’s loss so that he or she won’t exceed their intended risk. Here are the basic steps on how to do this with an example.
Step 1: Account Size
You must know how much money you have in your account. This might seem simple, but nonetheless is still crucial.
Step 2: Capital in Risk
How much are you willing to risk. In our example, let’s assume you have $100,000 in your account and are willing to risk 1%.
Step 3: Choose Market
Choose a market that you are willing to take a position in. For this example, we will use the Futures Oil market. For those that don’t know, 1 tick*= 0.01= $10.
Step 4: Your analysis
This step has 3 components to it, you must find them before you initiate your trade:
1. Entry point
2. Stop loss point
3. Profit target
These limits should not be based on one’s personal limits. Instead, base these limits on what the market seems to be projecting. Continuing with our example, let’s say the market projects limits of 65.50 for an entry point and 65.25 for a stop loss point. These should be the points you chose.
Step 5: Trade Size Calculation
Based on the previous step, this is a 25 tics difference which equals a $250/contract. This allows you to risk 4 contracts totaling in $1000 which was the 1% you decided on in Step 2.
As opposed to leaving you and your capital open to further losses, this method allows traders to control their risk under their own rules while keeping themselves within the market conditions.
Here is what you should NOT do:
Many times traders only follow the first three steps while ignoring the fourth. This is a big mistake as it allows their capital risk to be wiped out much quicker. For example, if one were to decide that the stop loss point is 65.40, they can still take a position of 10 contracts totaling in $1000 (as a reminder: each contract contains 10 ticks which equal $100). This would not be wise being that their stop loss point is too close to their entry point and thereby, gives the potential for a small change in price to erase their position. This not only erases one’s account but also prevents the trader from getting the opportunity to see if they were right and allowing the market to bounce back to where they predicted it to be.
Now you know the steps to calculate your position based on the stop loss and understand the significance of precise data points. Be sure not to skip any of these four steps in order to maximize profits.