Basic concepts of the risk management system

Basic concepts of the risk management systemWe all know that risks need to be managed. I'm going to buy a stock, futures or something else, and you know at what level you will come out, then you know how to calculate the optimal number of lots in a deal, especially I will show some examples and the simplest formulas for risk management on the stock exchange.

The 2 percent rule

There is a rule of thumb that tells us that we should not risk more than 2% of capital in every trade. I don't even know where I haven't seen this rule: it's everywhere. And I agree that knowing your risk in advance makes it easier to stick to the deal. That's where the first formula was born. The maximum loss in a trade is equal to the product of risk times capital:

MaxLoss = (Risk / 100) * Capital

If the capital is 10,000 rubles, then at risk 2% you have to risk an amount of 200 rubles, no more. Now we have something to start with when calculating the number of papers.

To calculate the maximum number of securities in order to keep the risk within the given limits, we must know the entry price and the exit price in case of an unfavorable outcome (that is, the limit price of the stop-loss). For now let's calculate all this with the broker's commission for buying or selling one lot:

Loss = |Input Price - Exit Price| + 2 * Commission

Note that in the formula we learn the absolute size of the loss (modulus). Suppose we want to buy a share for 200 rubles and sell it for 180 rubles, if it goes against us (for example, if it falls to 188 rubles). We calculate and obtain that the loss per share equals 20 (i.e., 200 - 180). We add double (since we made a deal in two directions) commission of 2 rubles, we obtain a potential loss of 24 rubles. Done, now let's calculate how much securities we can afford in this scenario:

Quantity = MaxLoss / Loss

Simply divide the maximum loss by the loss from one lot. In our example we get 200 / 24 = 8.333(3). Round it down to the smaller of the two and you get 8. That's it. We can buy eight shares.

If you've already made a trade, it's helpful to know the risk in it. Here's a complex formula:

Risk = ((Loss * Quantity) / Equity) * 100

Suppose we bought 15 lots for the same potential loss per share. So our risk equals ((24 * 15) / 10000) * 100) = 3.6%. Yes, we clearly exceeded it, cut the position!

Use these simple risk management formulasto stay within the limits of the allowed loss.

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