Financial spread betting and stock market trading in general is difficult and even the best traders incur regular losses. For this reason it is important to consider how much you are ready to risk from the beginning – and also how much you are prepared to lose. By doing this you can set your stop levels in line with your trading plan and in the process account for the worst-case scenario before you even open the spread betting trade.
“There is of course a degree of risk when trading the financial markets but these risks can managed with prudence. Learn everything there is to know about good money management meaning, not taking too much of a risk in reference to your capital.”
To first thing in this process is to find out how much you are willing to risk per trade. Most experienced traders agree that this should be limited to a maximum of 2 to 3% per trade, some say that’s too much and others say that’s too little but its a sensible starting point for risk. I myself rarely risk more than this (excluding particular situations). Let’s assume you have £5000 deposited in your spread betting account and that you are willing to risk up to 3% per trade. Your maximum loss from this trade would thus be £150 (3% of £5000). This is just one way of managing risk and creating your trade position size. Secondly, you need to check out your stop loss level with this particular trading setup. If you are considering to enter a deal with a stop loss level set at 50 points, then your stake could be £3 per point since this would cap a maximum loss of £150, which equates to the 3% that you were prepared to risk in the first place (excluding slippage). Likewise, if you intend to place a stop loss 15 points away, then you could be looking to enter a trade at £10 per point – again without changing the maximum amount at risk (£150).
So let’s look at position sizing…
Pot_£ 100,000
Risk_% 1.00%
Risk_£ 1000 (pot_£ x 100,000)
Stop 10
Spread Bet £100pp (risk £/stop)
Shares 10,000
It’s this simple. If your pot is smaller then the risk will have to be higher to deal with spread and costs, if your pot is larger you may want the risk to be lower. I have many open positions at any one time so work on a lower risk_%.
This is key because when your pot is £90k you won’t over-extend and when your post is £120k you will buy more. It doesn’t work well with a big pot on a Market Maker stock because you will find yourself oversize but the principle is sound. The other flaw in the pot is that it depends on setting good stops. And it’s the one rule of all the rules that I find the hardest to follow…..
One other thing – correct position sizing is important but you also need to think about how much you are prepared to see your pot fall. If I have £100,000 pot and I price every stock for 1% loss and I buy 50 shares, I am risking 50% of my pot. In my case I know that I run at +50% win:loss, so I can say I’m only risking 25%, assuming, that is, there’s not a market crash and my average performance continues. I think in general people spend too much time worrying about individual positions and not enough time nursing the pot.
“I fully concur with advice given by experienced investors about limiting each position (and/or the stop loss on it) as a percentage of overall pot, as a key part of risk management – to be learnt early, not sidelined in favour of studying stock selection techniques. Never lose more than 1-5% of your overall trading pot on any one trade and try not to get too overweight in any particular stock. Stock selection skills can be developed and honed later. Too many newcomers, in my opinion, get hooked too soon on stock selection as their number one area of interest.”