Newbies Only Part 6 by Trade Aptitude

trade planning Jan 07, 2025

Newbies Only Part 6

Happy New Year! The next several blogs are part of a multi-part process to tune up your trading plan for the coming year. If you haven’t read the prior five posts, you can find them here.

Today we’re moving on to risk management and the topic is so important we’ll be diving deeper and covering it over the next few days.

Every trade must have a stop loss order. This is the maximum you’re willing to lose on the trade. You can set this order when you enter the trade in two ways, limit, or market.

A stop limit order will be filled at precisely the price you set. That may sound good but considering price can move fast and it’s possible there aren’t enough counterparty orders at that price you may not get filled. You may experience severe slippage and lose more, sometime far more, than you planned. No good.

A stop market order will be filled when the price you set is traded. Most of the time you’ll get filled at your price. Sometimes you’ll get filled slightly worse or even better. Rarely will the slippage be intolerable. This is preferable, especially if you’re not watching the trade in real time.

On the rare occurrences the slippage was large you have the right to question your fill price at your broker. Call the trade desk and complain. Sometimes the problem was a technology issue, and your broker will adjust the fill. I’ve found success getting price adjusted around half of the time.

Where should you set your stop loss order? This will vary by strategy and market conditions. A quieter market will have less risk than a volatile market. For example, trading the S&P futures, our intra-day trend strategy uses a volatility-based stop that can range from 3.50 to 6 points. Our reversal strategy is fixed at 4 points. We know these limits are appropriate because the historical performance of the strategies proves so.

Now that you know the stop loss distance from your entry you can determine your position size. A common rule is to risk no more than 2% of your trading account on each trade. Assuming a $10,000 account, your maximum loss would be $200. If you’re trading a stock with a stop loss $2 away, your position size would be 100 shares assuming you have the equity in the account to buy/short 100 shares of that stock. Many newer traders will risk even less percentage. Start small until you’re confident.

Are some trade setups too risky? Yes. In a volatile market you may be offered an entry that requires so much risk your position size would be too small to execute the strategies exit rules. For example, all our strategies have multiple profit targets. They trade a minimum of 3 futures/options contracts. If the risk was high enough to limit your position size to 1 or 2 contracts you should pass on the trade. It’s better to remain consistent with the strategy rules.

Can there be too little risk? Yes. In a very quiet market, the stop loss might be so close to your entry price that it’s not giving it enough “wiggle room” to accommodate the price noise. Obviously, this only applies to strategies that have a volatility-based stop loss. Pass on the trade.

Should you move your stop loss order? Yes, but never for greater risk. Your strategy should have rules that allow you to tighten the stop loss order as price goes in your direction. Many traders like to get their stop to breakeven quickly to eliminate risk altogether. That may sound good but know in advance that you’ll see many of your breakeven trades went on to become solid winners. The decision is yours and it is a matter of style and risk tolerance.

Newbies Only Part 6 by Trade Aptitude

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