There are 2 types of trading – NON-LEVERAGED & LEVERAGED
With an initial assumption that 50% of the trading capital should be used in either of them one can follow the Risk Management Rules given below:
NON-LEVERAGED
1. Underlying covered: Stocks – Intra day (buy/sell) and Positional (buy)
2. Max 20% of the trading capital per trade (Trade Size)
3. Risk of max 2% of Trade Size
4. Risk-Reward ratio of 1:2 for normal traders and 2:3 for aggressive traders
Example – if 500000 is the trading capital. 50% of the trading capital is used for non-leveraged trading i.e. 250000. Max 20% of the trading capital i.e. Trade Size is 50000 and risk of max 2% per is 1000, then in extreme conditions: For normal traders, Risk=1000 & Reward=2000 and for aggressive traders, Risk=2000 & Reward=3000
How to trade Risk of 2%:
1. Calculate risk of max 2% of the Trade Size
2. Calculate Risk Factor i.e. Buy price minus Risk (stop loss)
3. Calculate Maximum Number of Shares to buy = risk of max 2% of Trade Size divided by Risk Factor
Example – if 250000 is the trading capital for non leveraged trading, Max 20% of the trading capital is the Trade Size i.e. 50000 and 2% of Trade Size is 1000. Now, if a stock is at 100 and risk (stop loss) is 95, then Risk Factor = 5 (100-95) and the Maximum Number of Shares to buy becomes = 1000 divided by 5 = 200 shares. The Maximum Number of Shares can change with the change in the Risk Factor but the factors like absolute risk of 1000 and Max 20% of the trading capital per trade will remain the same!!
LEVERAGED
1. Underlying covered: Stocks, Futures & Options, Commodities, Forex – Intra day/Positional (buy/sell)
2. Max 50% of the trading capital for leveraged trading. Rest of 50% for non-leveraged (even if you are not doing non-leveraged keep the cash aside!!)
3. Max 75% of the leveraged trading capital should be used at a time as margin money.
4. Risk of max 1% of the contract value
5. Risk-Reward ratio of 1:2 for normal traders and 2:3 for aggressive traders
Example – if 500000 is the trading capital. 50% of the trading capital is used for leveraged trading i.e. 250000. 1% is the risk attached per contract value. If Nifty is @5000 & exchange margin is 25000 per contract, one can trade max of 7 contracts with 187500 (75% of 250000) as margin money.
The total contract value is 7*50*5000=1750000. Then in extreme conditions- For normal traders, Risk=17500 & Reward=35000 and for aggressive traders, Risk=35000 & Reward=52500
So, approximately 17500/7=2500 is the maximum risk attached per trade. If the trade goes completely wrong and trader loses max of 17500, it is 7% of leveraged trading capital which is greater than the extreme loss of 2% in non-leveraged trading. After all it’s a risk attached to the leveraged trading!!! That’s why it is always advisable to use only 50% of the total trading capital for leveraged trading.
This is an extreme loss condition where 75% of leveraged trading capital is used as margin to trade maximum contracts. A trader can judiciously take the trading decisions and control the extreme conditions. This was an example for Nifty which is considered to be less volatile compared to other contracts traded.
Please note that these are specific tried and tested Risk Management Rules. So, traders should use them directly. Any modification in it will lead to confusion and it should be best avoided!!
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