How to do Risk Management on Your Trading Strategies?

It is humanly impossible to be 100% correct in all trades, irrespective of how thoroughly we research stock markets. This is why we must think about limiting the risk undertaken for each trade. Moreover, knowing where to draw the line helps you refrain from overburdening yourself.

In that case, what should be your risk tolerance? Let's find out. The most commonly recommended rule by experts is the one percent rule. This means that a stock trader must not lose more than one percent of his total position value in a single trade. So, if your account holds positions worth one lakh, your maximum loss per trade should be within one thousand. That's why you should always place an appropriate stop-loss on your trades. You should adjust your position size as per the loss amount predetermined by you. Position sizing involves calculating the number of shares, lots, or contracts you will trade based on your predetermined risk per trade. For example, if you are buying a particular share at rupees 100 and keep a stop-loss at rupees 95, your loss per trade is 5, and hence your position size will be 1000 divided by 5, which is 200 shares.

How much risk you take depends on how comfortable you are with the potential loss of capital. This is why some traders also push their risk tolerance to two percent. But how does this slight change make a difference? Let's say A has a position of rupees 50,000, whereas B has rupees 1 lakh. A uses a threshold of two percent, whereas B uses one percent. This effectively means that both A and B will lose 1000 per trade, despite the sizeable difference in their account balance. As both have different levels of risk tolerance or risk appetite.

While mentioning risk tolerance, it is also important to mention emotional control. Greed and fear are the two emotions that you have to deal with strongly. You should always exit the trade when your maximum affordable loss has been reached. Holding on to a loss-making trade with the hope of recovery can deepen your losses. A risk management strategy in stock trading is as important as a sail is to a boat. If the price moves opposite to your expectations, you should recalibrate and exit your position without much delay. It's generally recommended to avoid risking a significant portion of your total capital on a single trade. Diversification is key to risk management. Consider allocating a fraction of your overall capital per trade, such as one percent to five percent, to ensure that losses on individual trades do not severely impact your portfolio.