How to Calculate Your Risk When Buying Stocks and Options

RISK CALCULATOR

Account Size: $

HIGHER RISK (5%)

Max Stop Loss: $ 250

Max Daily Loss: $ 500

Daily Goal: $ 500

MEDIUM RISK (2.5%)

Max Stop Loss: $ 250

Max Daily Loss: $ 500

Daily Goal: $ 500

LOWER RISK (1%)

Max Stop Loss: $ 250

Max Daily Loss: $ 500

Daily Goal: $ 500

If you lose your first 2 trades, you stop trading for the day, and evaluate how you can do better next time. What was wrong with the setups you took?

If you lose your first trade, but win on the second trade, you can keep trading until you hit either your max daily loss or your daily goal. Obviously aim to stay green, and patiently wait for your high convicton setups.

Once you hit your daily goal, stop trading, or size down considerably so you dont give up the profits you already made on the day. You want to end the day green and above or close to your daily goal.

POSITION SIZING

Notice I have not mentioned how much to place in a trade, nor am I sizing based on what I want to actually make in a day. That is because rather than focusing on your position size, focus on the risk. As you grow your consistency and are profitable, your account size will naturally start to grow and you will start making more profits, and your daily goal will increase as a side effect, not as the primary goal!

In the above scenario, you could have 4 contracts of SPY at $2.50/contract = $1,000 position size, then place a stop at 25%, thus risking $250 on the trade.

Or you could have bought just 2 contracts of SPY at $2.50/contract = $500 position size, then place a stop at 50%, thus risking the same $250.

The first scenario has more conviction with a tighter stop (higher risk:reward), while the second scenario has lower risk:reward due to lower conviction, yet both trades are risking the same amount.

As your account grows from $5,000 to $10,000, you could choose to lower your risk from 5% of the account to just 2.5% of the account. Thus you will continue to make the same daily goal, but be risking half as much of the account on every trade. Alternatively, you could keep the risk percentage the same, but increase your position size. The key to deciding this differs by the individual and what their risk tolerance is, as well as how consistently profitable they are.

With a 10% daily account size risk, you would need 20 losing trades in a row (or 10 losing days in a row) to completely blow up your account. However, it would be wise for you to survive longer by reducing your position size as your account size decreases, thus staying in the game longer.

TRADING FUTURES (/MES)

You can also use the above risk management strategy when trading Futures (eg /MES). When trading futures, you are required to use margin. I like to use Tradovate due to their low commissions and low margin requirements.

Even though I have started with a $5000 account size in my Tradovate Futures account, I am able to buy 30+ MES contracts at $3700 each if I wanted to. I STRONGLY RECOMMEND AGAINST THAT as that would be a one way ticket to blowing up my account and getting margin called.

Instead, I just trade 3 contracts of MES and usually with a 5-10 point stop. Thus, with futures, my max risk in a trade is always defined at $50/contract = $150 total per trade. Most moves are 10 - 20+ points ($300+ profit) so I have a good risk:reward ratio., where I am usually risking $150 to make $300+.