Manage Your Trade Risk and Profit Exits.When you get on an airplane, just as the plane taxis down the runway, the stewardess or steward shows you how to comply with the safety rules. One of the rules is to locate the nearest exit which is not a bad idea in case it could save your life.
When you go to the movie theater to enjoy the Big Screen, one of the preview clips is about safety and to locate the nearest exit. Another good plan. In fact, it is always a good plan to know your exits no matter what.
Since trading (the act of buying and selling) is a business(or it should be), whether you are trading baseball cards, real estate or in the various financial markets, you should always have a plan for at least 2 exits; one when you reach your profit target and one when you reach the risk you have predetermined.
Different trading business ventures call for different risk to reward (profit) ratios.
In stocks, it could be 1:2
In options, it could be 1:3
In baseball cards it could be 1:1
Knowing your risk and profit exits will help you determine if a specific trade has enough probability to meet your plan.
Now the task is to find a trade and determine how many shares or option contracts you can trade to fit your risk to reward (profit) ratio. This is known as position sizing.
A good rule of thumb in trading stocks and options is to only risk 2-3% of your trading account value on any 1 trade and no more than 5% per day. Once you have arrived at your risk capital amount, then you can multiply that by your ratio to find what profit target you are seeking.
Total trading account is $10,000
Risk per trade is $200-$300 (2-3%)
Risk per day is $500 (5%)
Profit Target for a 1:3 ratio would be risk $250 to profit $750
Take these 2 exits and go find a stock chart that this will work with. This method will help you narrow down your candidates and increase your probability for successful trading.
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Don’t have a trading plan? Haven’t defined “successful” yet? Check out our blog posts.