When playing the market you are either taking the stance as a trader or investor. It might not sound like a big difference but it really is.
As a trader you are quickly in and out of positions as you are aiming to capitalize on short term movements. Thus when you enter a trade, like investing you do so always with risk management in mind, but the amount of portfolio risk you are going to be taking/comfortable with varies.
Most time you are after at least a 2:1 risk/reward ratio unless the technical set-up is really good then 1:1 is alright. If the trade goes south you only want to lose 2% of your entire account size, max. This will keep you in the game longer and allow you to retain your profits from other profitable trades. Remember especially when using leveraged instruments it only takes one bad trade that you let run away to really blow up your account, especially trading futures contacts and FOREX.
When I talk about: risk management, risk to reward and a good technical set-up I am assuming that you understand technical analysis. For instance if you see a head and shoulders pattern confirm, you enter the trade and place a stop loss so that at max you will only incur a 2% hit to your portfolio as a trader. Thus placing your stop above your line in the sand of where the technical set-up occurs enough so that your 2:1 risk/rewards is in check and at max a 2% loss occurs. I will work on getting a few actual stock charts with price patterns and lines drawn for examples in the future in case you are having a hard time following along.
Investing is a little different, you are less worried about the day to day, week to week volatility in the market and thus your longer term view approximately nine months out and beyond will see less trades. You will be less picky with entry selection and be able to allocate a 5% draw down in your portfolio before worrying about exiting the position.
2% for traders per trade and 5% for investors per investment is a general rule. Depending on your risk tolerance you can tweak these percentages. However it is necessary to remain consistent. 2% on one trade, 1% on another and 3% following is not sticking to your rules and is going to end up hurting you in the long run.
Paper trading is a great way to start, but because you don’t have real money in the game it removes the emotional aspect that actually is the hardest thing to control when playing the market. I recommend paper trading to start but not forever.
I know I went through this quickly and as always if you are confused leave a comment below.