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

1. Always know your maximum loss before entering
2. Never average down on a losing position
3. Cut losses, let winners run
4. Size positions based on risk, not conviction
5. Survive first, profit second