Advanced Stock Market Trading - Level 1_8. Risk _ Position Management

Lesson 8: Risk & Position Management

Managing A Position

Before we enter a position of risk, we must examine the target and analyze the stop
loss points and define them in advance. What are the main reasons for stopping loss
points?

In case of a stop-loss order, the trading company or broker looks at the trading
discipline to help the investor cut losses by the current market bid price (i.e.
the highest price for the stock at any point of time at which the investor wants
to place a bid), and vice-versa, while selling a stock. 

A stop-loss order is basically a tool used for short-term investment planning. It is
used when the investor doesn’t want the pressure of monitoring a security on
a day-to-day basis. The trade gets triggered automatically and the limits are
decided in advance.

We must also have a comprehension of why we manage risk. Why do we manage
risk?

We manage risk because it allows us to discern between multiple actions and by
using the tools we have learned, select the right course of action that will benefit all
parties concerned.

These are a few examples which can help manage risk: 

The size of your position

● Hedging - taking multiple positions at once in opposing markets
● Trading during certain hours
● Stop Losses and Take Profit levels
● Knowing when to take losses

An important way is getting an acceptable risk/reward ratio established and stick to
it.

Risk Reward Ratio

Some people start their first good ratio for their first target at 1:1 or even 2:1 where
your profits will double that of your maximum loss. Therefore, even if you had three
losses, you would only need two gains to certify your overall profits be more than
your losses when sticking to this risk reward ratio.

We’re going to look at two examples, both starting with $10,000 and using the 2:1
risk reward ratio but applying extremely different routes of money management in
their trading. The initial trader uses a highly assertive approach, risking 60% of his
capital on every trade, and striving to make a profit at 120%. Meanwhile, the
secondary trader is more cautious, and only risks 5% of his account assets targets in
profit of 10%. For ease, let’s say that both traders had the same set of ten trades,
and that each second trade was profitable.

These tables show the trading results of two traders using different levels of risk
management.

Even though both strategies had equal rates of success, the same initial capital and
the same 2:1 reward risk approach, because of a severely dissimilar money
management style, the final results differ considerably. The first trader’s aggressive
approach resulted in a total loss of 47%. However, the second trader enjoys almost
25% total profit at $12,462.

Therefore, you can see how a small adjustment to your approach to risk
management could give you healthier returns.

- The correct risk reward ratio is critical to helping avoid loss over time
- Our targets are determined according to historical behavior, support,

resistance and round numbers

Risk Management

The process of identifying, analyzing, assessing, and communicating risk and
accepting, avoiding, transferring or controlling it to an acceptable level considering
associated costs and benefits of any action taken.

The process of determining maximum levels of risk through risk assessment, then
strategizing to reduce or control the chance of loss, and maximize the opportunity to
gain’

How do we do that? Things you need to understand about Risk Management
Respect price, respect risk and always be prepared for any outcome. 
There is always a chance of being wrong on a trade – as there are no assurances
that price will move up or down at any point in time.
Always have a Risk Reward Ratio that you do not stray from.
Account Management - It is best practice for your Risk (%) per trade to be no more
than 1% -2% of your account balance

Moving Averages

A tool that helps us to confirm the trend and to alert us of a possible change in
direction
The moving average is calculated according to average closing prices during a
defined period and appears as a continuous line on the chart
Moving averages are not the only tool used in the decision making process but
should be one component that forms a trading idea
The main idea is that you shouldn’t risk more than 5% of your total capital in a
position. The purpose for this is that trading is centered on probability and you ought
to give your strategy a venture of assessment, to ascertain whether you have a
larger probability of achieving success rather than defeat.

The Simple Moving Average (SMA) is a popular trend-following indicator. When
graphed on a chart, it filters out the day-to-day noise in security prices, revealing the
longer-term trend. The following chart shows the TSP C Fund along with its
10-month SMA:

Investors can use the SMA as a signal to time the buying and selling of a security. In
an upward trend, the investor buys the security when its monthly closing price
crosses above the SMA, rides the trend, and then sells it when the trend direction
reverses and the price crosses below the SMA. Below is the same chart as before,
with the Buy (B) and Sell (S) trading signals added. You can see that the strategy
had its last Buy signal on 1/31/2012:
Fibonacci
Fibonacci (c. 1175 – c. 1250) was an Italian mathematician from the Republic of
Pisa, considered to be "the most talented Western mathematician of the Middle
Ages".
Fibonacci popularized the Hindu–Arabic numeral system in the Western
World, primarily through his composition in 1202 of Liber Abaci (Book of
Calculation). He also introduced Europe to the sequence of Fibonacci numbers,
which he used as an example in Liber Abaci.
Numbers Series

The Fibonacci Sequence is the series of numbers:

0, 1, 1, 2, 3, 5, 8, 13, 21, 34, ...

The Golden Ratio
And here is a surprise. When we take any two successive (one after the
other) Fibonacci Numbers, their ratio is very close to the Golden Ratio"φ" which is
approximately 1.618034...
The Fibonacci numbers are significant because of the so-called golden ratio of
1.618. In the Fibonacci sequence, any given number is approximately 1.618 times
the preceding number. This golden ratio is ubiquitous in nature where it describes
everything from the number of veins in a leaf to the magnetic resonance of spins in
cobalt niobate crystals.

Many traders believe that the Fibonacci numbers and golden ratio play an important
role in finance. In particles, many traders are focused on three percentages based
on the golden ratio, including 38.2%, 50%, and 61.8%. These ratios are created by
dividing the next highest number (e.g. 89/55 = 0.618 and 13/34 = 0.382). Using this
technique, traders can calculate percentages as high or low as needed.
These percentages are applied using many different techniques:

Fibonacci Retracements 

These are horizontal lines on a chart that indicate areas of support and
resistance.

Fibonacci retracements are the most common form of technical analysis based
on Fibonacci numbers, which can be seen in the example chart above. The
usage of the Fibonacci studies is somewhat subjective since the trader must use
highs and lows of their choice. When building trading systems, traders may
choose to select a high and a low during a set period of time.

Many traders use Fibonacci numbers and lines in conjunction with other forms of
technical analysis. For example, traders may use look for conformation of a
breakout from a Fibonacci retracement by looking at on-balance volume or
the relative strength index (RSI). These studies may also be used in conjunction
with chart pattern analysis, such as ascending triangles or flags to calculate
take-profit or stop-loss points along the way.