Money management rules for stock trading

Money management rules are obvious part of every good stock trading strategy.

These rules should answer these questions:

How big is my risk for one trade ?
How many opened trades I can have at a time ?
What is my risk:reward ratio ?

and other important issues

These money management rules will help you to identify how much shares you can buy or sell short in particular trade.

How big is my risk for one trade ?

Definition of maximal risk value for one trade could vary a little bit. Generally used numbers are between 0.5% till 2% of total account size.

Example:
Account size is 100 000 USD. The maximum risk per trade is 1%. It means that you can risk 1000 USD on every trade. If distance between your entry and stop loss level is 1 USD, then you know that you can open trade with 1000 shares . Simply calculated by (absolute risk) / (point of distance between entry and stop loss level).

Should you open trade with 1000 shares ? No ! You must check another money management rules and combine results.

My stock market trading tip:

If you are beginner in trading, start with small risk . Use 0.4% or 0.5% risk of total account value. And as your confidence will grow and your trading journal will report your success, increase it.

How many opened trades I can have at a time ?

It is not easy to manage trades by moving stop or taking profits manually if you have a lot of trades and only two hands ! You must be able to manage trades manually in case of any strong move on stock markets. Even your trades are not day trades but you are swing trading on stock markets, it can happen. So every trader must limit maximum number of opened trades. Absolute maximum for single person is 8 open trades at once. This hard limit should not be surpassed.

Five or six open trades at once as a maximum is appropriate limit for every trader.

Example:
Your swing stock trading account size is 100 000 USD. You decided to have max. 5 open trades at once. Your broker provides you with 2:1 overnight margin. That means that you can use for one trade 40000 USD. How it was calculated ? 100000 x 2 / 5 = 40000. So when you plan to buy XZY stock with stock price 20 USD, this rule tells you that you can buy max. 2000 shares. Combine it with number of shares from previous rule and use LOWER value for your trade setup.

Special stock market trading tip:

During first years of your trading set this number of trades to lower value (like to 3 or 4 max)

What is my risk: reward ratio ?

Never ever try to have risk reward ratio less then 2.5 to 1. This rule is crucial in your trading statistics. Especially if you are new in trading and without any relevant trade history, set this ratio to 3:1.

Other relevant issues

There are also other important rules, which are part of stock trading strategy.

Trade only liquid stocks. Such stocks have average daily trading volume over 300 000 shares traded per day (for swing trading stock ) or above 1 000 000 shares per day (for online day trading of stocks)

Trade stocks with price above 5 USD. Stock with low price are not traded by big institutional traders and therefore are easily manipulated. Technical analysis can fail on such stocks. Also most of big investment funds do not invest into such low priced stocks.

Another of my tips on stock market trading:

All money management rules can be easily defined in spreadsheet (like Excel or OpenOffice Calc) and then all values are calculated automatically as you are entering your setup entry , stop-loss and targets .

Here is example of such spreadsheet table:

money management spreadsheet example

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