Risk:Reward lets us know that the trade is worthwhile

• • Total risk should never exceed 2% of your entire portfolio (What you are willing to lose on a trade)

  • eg. $10,000 x 2% = $200; this means you could lose 50 trades in a row before losing your entire portfolio

  • This gives you time to adjust your strategy to improve on each trade

  • eg. $500 x 2% = $10

Position Size tells us how much of our total capital we can invest in a single trade

• • You should keep your position size should never exceed 50% of your portfolio per trade

  • Maximum portfolio used on a trade is 25%

  • Each trade should never exceed 8% of your position size

  • eg. $2500 x 8% = $200; notice how 8% of the trade matches up with 2% of your portfolio

  • On average, you want to keep you losses to 5-6% per trade to protect your money

  • eg. $500 x 25% = $125; $125 x 8% = $10

Our position size is determined by our risk. (Max Loss/Trade Risk = # of shares we can purchase).

• We will still respect the 25% max recommend positioning/50% cap on any investment (though it should be less)

• Our risk should still be capped at 2% of our capital

Let's assume our capital is $1,600 in the examples below.

Example

• • • $1,600 x 25% = $400; $1,600 x 2% = $32 total risk

    • Stock price = $75, Stop Loss $65, trade Risk $10

    • If we cap out at $32, we can purchase 3 shares ($32/$10 = 3 shares)

  • We would spend 3 shares x $75 = $225

  • Though our max position size is $400 (25%), our risk dictates that we can only purchase 3 shares based on a $10 risk

  • This is why we want to find entries that can limit our risk and increase the number of shares we can purchase

Example 2

• • • $1,600 x 25% = $400; $1,600 x 2% = $32 total risk

    • Stock price = $50, Stop Loss $46, Trade Risk = $5 per share

    • If we wanted to cap out each loss at $32, we can purchase 6 shares ($32/$5 risk = 6 shares)

    • We would spend 6 shares x $50 =$300

Example 3

• • • $1,600 x 25% = $400; $1,600 x 2% = $32 total risk

  • Stock prices = $1,000, Stop Loss $1,060, Trade Risk $32

  • You could not enter this trade since the maximum amount you can use for a position is $800 ($1,600/2)

Determine the following using the information below.

Exercise 1

• $2,500 total capital

• Max trade based on capital (25%)

• Maximum risk per trade (2%)

• How many shares could you purchase if the Stock price = $30, Stop Loss $28, trade Risk $2

• What is the risk:reward ratio if you are targeting $35?

• Is the trade worth entering?

Exercise 2

• $3,800 total capital

• Max trade based on capital (25%)

• Maximum risk per trade (2%)

• How many shares could you purchase if the Stock price = $45, Stop Loss $41, trade Risk $4

• What is the risk:reward ratio if you are targeting $49?

• Is the trade worth entering?

Exercise 3

• $4,700 total capital

• Max trade based on capital (25%)

• Maximum risk per trade (2%)

• How many shares could you purchase if the Stock price = $63, Stop Loss $56, trade Risk $7

• What is the risk:reward ratio if you are targeting $80?

• Is the trade worth entering?