Risk Management And Placing Stops: How They Relate

All traders want to be able to excel at risk management. The ability to place stops to protect trades is a helpful way to achieve that success. A question that pertains to this came up in the Apex Investing Forum recently.

Sometimes it may seem that the more you learn as you begin trading, the more confused you become. Luckily, other traders were there to answer the question for this beginning trader. He wanted to know how to determine the number of contracts to trade, and if placing stops related to the amount of contracts he traded. He also wanted to know if the number of contracts traded had any bearing on where trailing stops should be placed.

At first glance, these parts of trading might not seem to relate at all. You place your stops based on your entry, the amount you are willing to risk and the instrument you are trading. Trailing your stops protects your profits and limits your losses. It does all fit into risk management as explained by some traders who answered the forum questions.

The example was given that if you had $5000 in your account and you were willing to risk two percent that would be $100 risk per trade. In assessing your trade possibilities, you look at your chart and as a confirmation is developing, you see that the logical stop at entry, following the rules is the previous swing low/high and it is 40 ticks away. Each tick is worth one dollar for spreads giving you an initial risk of $40 per contract if using NTM (Near the Market) spreads.

If you are willing to risk $100 per trade, you could do two and a half contracts (100/40 = 2.5), but since you cannot do a half contract, you would only do two contracts.

But what if the stop was 60 ticks away instead of 40? Then you would only be able to do one contract because if you did two, you would exceed your max loss per contract of five percent or $100. Likewise, with the same $100 risk and the stop at $50 per contract, you can have two contracts. If the stop is $20, you could do five contracts, etc.

Be sure to adjust these values as your account grows or decreases in size. Protecting your account as you trade from day to day allows you to continue you trading in the future. You want to be able to still be trading in twelve months, not just twelve minutes!

To learn more about risk management and trading education, visit www.apexinvesting.com, a service of Darrell Martin.