Stock Market Risk Management
Proper risk management is what separates successful traders from those who blow up.
Position Sizing
The 1-2% Rule
- Never risk more than 1-2% per trade
- Calculate based on stop loss distance
- Formula: Position Size = Risk Amount / (Entry - Stop)
Example
- Account: $50,000
- Risk: 1% = $500
- Entry: $100, Stop: $95
- Risk per share: $5
- Position size: 100 shares ($10,000)
Stop Loss Strategies
Fixed Dollar Stop
- Predetermined dollar loss
- Simple and consistent
- May not match market structure
Technical Stop
- Below support level
- Below recent swing low
- Below moving average
- More logical placement
Percentage Stop
- Fixed percentage from entry
- 5-8% for swing trades
- Adjusts with position size
Trailing Stop
- Follows price as it rises
- Locks in profits
- Can use ATR or percentage
- Automatic on most platforms
Portfolio-Level Risk
Maximum Exposure
- No more than 20-25% in one sector
- No more than 5-10% in one stock
- Keep cash reserve (10-30%)
- Diversify across sectors
Correlation Risk
- Correlated stocks move together
- Holding all tech = concentrated risk
- Diversify across uncorrelated sectors
- Check correlation before adding positions
Protecting Against Black Swans
Diversification
- Multiple asset classes
- Geographic diversification
- Different time horizons
Options Hedging
- Buy protective puts
- Collar strategies
- Portfolio insurance cost
Cash Position
- Always keep some powder dry
- Opportunities come during crashes
- Cash is a position too
Key Rules
- Always know your maximum loss before entering
- Never average down on a losing position
- Cut losses, let winners run
- Size positions based on risk, not conviction
- Survive first, profit second