Risk Management & Capital Allocation are topics that are ignored most of the time by new or even experienced traders. Until this, through the Beginner’s Guide to the Stock Market series, we have discussed everything about the basics of trading and technical analysis.
Now it’s time to discuss the most important part of trading, and that is Risk!
Generally, when new traders enter the market, they are always in search of that one strategy that will make them tons of money, but we all know there is no such strategy. According to my observation, most traders focus on technical analysis or strategy, and very little attention is given to risk management and capital allocation.
I will give you a practical example of this. Consider an experienced trader who is highly experienced with an excellent strategy here, we call him a trader ‘A’ and consider a new trader. Let’s call him trader ‘B’. Give them 10-10 Lakhs each. Now, trader “A” has to do exactly the opposite of his system i.e if his system is generating a buy signal he has to sell, and if his system is generating a sell signal he has to buy. On the other hand, trade “B” can follow the original strategy.
After a year, who do you think will make more money? The answer is obviously trader “A” because he knows how to manage the risk, he knows how to hold the winning trades, and these are the reasons why due to which trader “A” can make more money than trader “B”.
In simplest words, Risk Management is understanding the risk you are taking and managing it every time. Let me introduce to you a concept called Risk Per Trade (RPT). It is the risk you are willing to take for every trade you make. For example, Let’s say my account size is 1 lakh and my risk per trade is 2% of my capital. According to this, I can’t lose more than 2k on any trade, no matter how good the opportunity is.
Every trader’s risk appetite is different. For example, some traders may want to capture 8 or 10% returns in one day and for that, they are willing to risk 4 or 5% of their capital, on the other hand, there are some traders, those who want to risk 0.25% or 0.50% and aim to get 1% or 1.5% returns. There is no such rule that you must take only 2% risk per trade, everyone’s trading approach is different and capital allocation as well.
As of now, you may have got an idea about the Importance of Risk Management and How Everyone’s Approach is Different while managing the risk. Now, the question arises: What Approach Should I Take As A Beginner?
As a beginner, initially, you should follow fixed rules. Such as If my 2 stop-losses get hit, then I will close trading on that day, I will only risk 2% or 2.5% of my entire capital per trade. When you trade frequently, you will automatically get to know how your system is behaving in different market cycles. Once you get to know about your high probability trading setups then you allocate your capital accordingly.
Every trader needs to understand one important thing. No system can make a profit every single time. There are drawdowns to every system, the point is how much you win when you win and how much you lose when you lose. So, whenever you are continuously losing trade less, cut down your position sizing and when you are continuously winning, take more risk.
Generally, amateur traders do the opposite of this, they increase their position sizing when they are losing and they cut down their sizing when they are winning.
I hope that, through this article, you got some valuable information about risk management and how a beginner can manage their risk while trading. If you are interested in learning more about chart patterns, then you can definitely check out my previous blog on How to Trade Wedge and Triangle Chart Patterns| Beginner’s Guide To The Stock Market | Module 13. Also, if you have any queries regarding this topic, then please post them in the comment section.
If you want to know more about Risk Management & Intraday Trading Strategies you can refer to our previous blog on