“The House always wins.”
That’s true of gambling, but it doesn’t hold true for investing. While there’s no such thing as a “safe” investment, there are things you can do (perform analysis, control losses, invest with strategy and purpose) that can align the odds in your favor and set conditions such that even when you lose, you control those losses.
Remember the first rule of money management: Preserve your capital at all costs. Again, the reason for this is simply that if you lose your investing capital, the game’s over. Proper position sizing is a crucial element of capital preservation, and this is another topic about which entire books can and have been written.
Obviously then, giving this topic an in-depth treatment is quite beyond the scope of this course, so instead, we’ll summarize.
This is the real-world expression of the old adage “don’t put all your eggs in one basket.” If you have $10,000 to work with, the last thing on the planet you’d want to do is to put all $10,000 of those dollars on a single trade, in a single position of one company.
Sure, the stock price might take off, and if it does, you’ll make a mint.
Of course, the stock price could also tank, in which case, you’re at dire risk of losing your entire kit and being out of the game. Not good.
Every person’s risk-tolerance is different, but in general, seasoned traders adopt something close to this paradigm: As a new trader don’t risk more than 1% of your equity on a single position.
It’s a short phrase, but there’s actually a surprising amount to unpack in it, so let’s have a closer look.
Your equity is simply the sum-total of the value of the money you have to work with in your investment account, and the value of your currently open positions.
A “position” however can mean a few different things. First and most obvious to the eye is that if you mean to buy shares of a given company at a given price, then that’s a position, but consider:
• If you currently hold stocks in several banks, those should probably be seen as “one position” even though they’re different companies – simply because banks are in the same industry and tend to perform in tandem, or pretty close to it.
• In a similar vein, if you own both gold and silver, those should collectively constitute “one position” because precious metals also tend to move generally in the same direction.
• The same is true if you’ve invested in multiple cryptocurrencies, and so on.
Thus, if you have $10,000 to play with, the maximum amount of capital you want to put at risk in any one trade is no more than 1%, or $100, but that reveals a new problem. If you have a smallish account like this, you may find that it’s difficult (if not outright impossible) to purchase the minimum parcel without violating the 2% rule. What do you do if, say, you have to take a position size that sees you putting 6% of your equity at risk?
There are a number of different ways to answer that question:
1) Don’t make the trade. Consider the 1% rule to be ironclad. Look for a different opportunity.
2) Make the trade because you have to, but watch it closely
3) Find a different market to trade in that has minimum requirements you can meet, given your current equity stock
A fourth possibility is, of course to refine your approach and find another, better entry point such that fewer of your precious dollars are at risk. That is what we’d recommend, and now you begin to see the various pieces of the puzzle coming together.
Note that there is one thing you absolutely do NOT want to do, and that is to just arbitrarily place a stop to cut your losses at $100.
Arbitrarily placed stops like that are a surefire way to lose money, because you’re placing them when and where it just doesn’t make sense to do so (i.e., odds are that the natural price movement will take your stop out, and you lose money when you shouldn’t have). Avoid developing that habit at all costs.