Most traders lose money not because of their analysis but due to wrong positing sizing. Although the analysis part matters a lot, how much to buy/sell is equally important, if not more. For a long time, I have focused more on the positing sizing than analysis in my personal trading which has helped me massively to improve my trading game.
Here I am discussing a very simple yet effective way to find out exactly how many shares you should buy on a particular trade to manage your risk.
Firstly, determine your total capital which will become the starting point for risk management. Let us assume you have INR 3,00,000 in your trading account. Now you need to gauge your risk appetite. As every trader has his/her own risk tolerance, there’s no hardcore rule here. However, it is recommended that a trader should not take more than 1% risk (of total capital) in any single trade.
Going with this 1% risk rule, you can arrive at the exact risk (in INR) you are allowed to take on a single trade. If your capital is INR 3,00,000, then 1% of it is INR 3,000. Now how to apply this rule in a real trading scenario?
Let’s assume, you come across REC (NS:) shares as a good stock to buy, as per your analysis which is currently trading at INR 100 (eg.). Your stop loss is INR 90, which simply means you have a risk of INR 10 per share on this trade. Remember, we calculated the total risk per trade to be INR 3,000? Now divided the total permissible risk by the risk per trade to get your optimum quantity of shares. Here, it is 3,000 by 10 which is 300. Now you know you can buy a maximum of 300 shares in this particular trade in order to keep your risk in check.
This position sizing technique is dynamic in nature, meaning if you face a drawdown your risk will automatically reduce to minimize your losses. Say your initial INR 3,00,000 is reduced to INR 2,50,000 on account of an INR 50,000 loss. Now your risk will also reduce by INR 500 to INR 2,500 (1% of account size).
In a similar fashion when you are making consistent profits, your risk-taking capacity will increase which could potentially fetch you higher profits.
If you follow this simple rule, you will never have to think about how much to buy and your chances to become a profitable trader will increase exponentially.