Stock Market: 11 Easy Ways To Manage Money And Risk In The Stock Market For Beginners

In The Stock Market, RISK COMES FROM NOT KNOWING WHAT YOU ARE DOING.

Without the proper application of risk & money management, the application of technical analysis to trading in the stock market today would be an exercise in futility.

Our story in the previous post had halted at how I reacted when I saw the candlestick chart and how I studied to read it eventually. 

Well, most of the stock market courses for beginners and stock market books usually start with the technical analysis part first and extremely important parts like money and risk management in the end.

But we will start the money and risk management part at the beginning of our money-making stock market course.  Remember the key takeaway from our previous post: Preserve capital at any cost in the stock market; If capital stays- you will.

Money management is critical to success and longer‐term survivability in trading. 

Alright then let's get started.

We will start with three main areas namely preservation of capital, choosing the right broker and risk each consisting of subtopics.

Preservation of Capital

1. Emotional Control

Refrain from emotionally attaching while in a trade if it goes in the opposite direction. If you continue staying in a loss-making trade believing it would return to the profit zone without any logical reason, the possibility is that it can further go in the opposite direction. This is one of the reasons for wiping out the whole capital. Hence it is necessary to learn to book losses and not to repeat the same mistakes again. There is no hard and fast rule that you have to trade every single day. We will be smart here, we will be entering in trade only when there is 100% set up which means an opportunity of handsome profit. Remember, the decision of not trading on a particular day = PROFIT.

2. Risk-To-Reward Ratio And Stop-Loss

It's extremely important that before entering in any trade we must calculate the R/R ratio of the trade. Generally, 1:3 is a sensible R/R ratio to follow in any trade, which means we can bear a loss of Rs.1/- if the underlying moves in the opposite direction. But if underlying moves in our analyzed direction we can have Rs.3/- profit.

 

Here our stop-loss becomes Rs.1/- and the target will be Rs.3/-. You can simply put a stop-loss order while trading so you can automatically get out of bad trade with less loss.

Also, you will feel comfortable and the probability of getting right will be greater as you know you have put stop-loss that should not get hit. Hence you will be forced to enter only trades which are 100% legit.

 

You must follow the discipline here. Do not modify stop losses once the order gets executed otherwise chances of loss-making trade increases. Let profits run, cut losses short.

3. It’s Not Gambling

It’s not a casino to gamble here. Treat stock market trading like your own business which has BALANCE SHEET, PROFIT & LOSS STATEMENTS and you are responsible for maintaining it. We must believe in thorough analysis technical and/or fundamental of stock market data.

Below is the definition of Gambler's Fallacy from Investopedia:

The gambler's fallacy, also known as the Monte Carlo fallacy, occurs when an individual erroneously believes that a certain random event is less likely or more likely to happen based on the outcome of a previous event or series of events. This line of thinking is incorrect since past events do not change the probability that certain events will occur in the future.

It’s not gambling if you know what you are doing. It’s gambling if you are just throwing money into a deal and praying. An idea in anything is to use your technical knowledge, wisdom and love of the game to cut the odds down, to lower the risk. Of course, there is always a risk. Its financial intelligence improves the odds.

4. Keep Trading Journal

Make a habit of noting down your trades so that you can have an idea of how much net profit/net loss you are making at the end of the week/month.

5. Position Sizing

You can limit the quantity of shares/LOT size(Eg. 1 Lot=500 shares) for trade if you are a stock market beginner or have less conviction about the trade you are entering. Maintaining the position size of the trade can save us from the RISK OF RUIN.

 

“Stock Market has enough for your need, but not enough for your greed.”

 

The dual function of money management may be classified as:

1. Sizing an exposure

2. Managing an exposure

Please find below image illustrating the money management sizing sequence:

6. Paper Trading

Trading with virtual money is highly recommended in the stock market for beginners. It helps to build confidence and experience in trading, also allows time for trying out different strategies and developing the best trading system for real-world trading.

 

You are allowed to make mistakes here so that you cannot make them while you trade with real money.

Choosing The Right Broker

1. History of Broker Firm &  Feedbacks

Compare the different brokers based on the reviews and feedback before opening the trading and DEMAT account. I will recommend you to keep both the accounts with the same broker.

The account opening process is easy nowadays if you have all documents ready.

2. Know Brokerages & Other Charges Charged by Broker

Always choose the broker with the lowest brokerages, even if brokerage charges look very small, it’s big money if you calculate at the end of the month. 

You can use the brokerage calculators available on the broker's site to find out brokerages for every instruments/stocks(INTRADAY, FUTURES, OPTIONS, DELIVERY) traded.

 

You can also check the margin required, leverages provided by the brokers by calculators.

 

Going through the Contract Note post-trade is highly important. You will get to see the different types of taxes and brokerages charged per trade.

Smart investors understand taxes before stock market investing.

3. Service Provided by Broker

I will recommend you to go through the services provided by your broker firm. Sometimes we have extra services activated on our account which we don’t need like trading calls ideas.

Double-check if the broker's service is up and running and not going down frequently. Also, reviews on the performance of the broker's stock market app. Check the support systems of the firm if tickets are getting resolved properly.

 

Most of the time we take these points for granted, but these are worth taking into consideration.

Risk

1. Investment is not risky for the financial literates

Now please have a closer look at the below explanation. This is the starting point to our incoming blog posts mainly focused on Technical Analysis.

 

A trader’s job is two‐fold, namely to:

1. Manage Entries and Exits

2. Manage Risk Exposure(MAXIMIZING PROBABILITY OF PROFIT WHILE MINIMIZING PROBABILITY OF LOSS)

2. Consider going long(BUY) in the below scenario:

We can find out whether the trader is Risk Aggressive or Risk Averse(Conservative) with respect to Price & Time of entry:

 

1. If a trader goes long @100: Aggressive in Time and Conservative in Price

2. If a trader goes long @120: Aggressive in Price and Conservative in Time

3. If a trader goes long @85: Aggressive in Time and Conservative in Price

 

In the stock market game, a trader who fails to consider the risks associated with his positions is certain to have a short and unhappy career.

SYSTEM TESTING & OPTIMIZATION: PERFORMANCE MEASUREMENT

BACKTESTING is an extremely important concept in developing the trading system for stock market beginners whether it is stock market Europe, stock market UK, stock market US or stock market India. Simply put, you build your trading strategy and test it with past or current data. To be able to call it successful it must produce profiting results at least for 50 trades in each type of markets; mentioned at the bottom.

 

When testing a trading system, data is employed to develop the trading strategy and test for profitability and long-term positive expectancy.

 

Generally speaking, the greater the amount of data used to back and forward test the system, the more reliable will be the results of the tests in gauging the expectancy and consistency of performance of the system.

 

For example, the minimum 50 trades may consist of data that is entirely related to a series of trades that occurred during a very strong market rally. Such stock market data may be biased and may not account for situations where the market was bearish or volatile. 

Hence testing a system under such limited market conditions will not produce a system that is flexible and robust enough to handle changing market conditions. Therefore, it is recommended that sufficient data be collected under a variety of market conditions, which should ideally include:

 

1. Ranging markets

2. Strong bullish and bearish markets

3. Highly volatile markets

4. Markets exhibiting gapping prices

Book Alert : 

THE INTELLIGENT INVESTOR

-BY BENJAMIN GRAHAM

KEY TAKEAWAYS:

• Avoid big loss, profit automatically follows.

• Choose broker carefully.

• No gamble; logic and analysis is the way to go.

• Don't trade impulsively, have a plan.

• Develop the strategy and build your own trading system; back-test it.

• Paper trade before entering the real market.

• Always start from Higher Timeframe and then come to a Lower Timeframe.

• Don't take anything said in financial media too seriously while trading.

• Act smart when using leverage provided by the broker.