MONEY & RISK MANAGEMENT SIMPLIFIED

In this article I am going to touch upon a couple of very critical topics which are either not known to many people OR
they take these for granted & in return pay heavy price for the ignorance. These 2 topics are –
1. Money management
2. Risk management

Let's start with a saying – A rupee saved is a rupee earned. Protection of capital is your first step towards making

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profits. If you don’t have capital left, then on what you will earn profits? We all enter markets with hopes, dreams &
ambitions to make money out of it. From outside, this world looks very dreamy & full of possibilities but very little you
know that it is not that easy as it looks from outside. So let's drill down more into it.

What is Money management & why it is important?

In simple language, Money management is nothing but making the best use of your capital to yield the best possible
results. It is vital because unless we know how to use the money to trade right, we will never be able to make the
best returns out of it. This helps you to sustain in the market for long run. It’s like Duracell vs. normal cell. People with
good money management skills last longer than those who don’t know this art. Simple!

Let's take an example:

You enter markets recently & you are very excited about it. You have very high hopes from the market & you think
"You know it all". You have some funds available from your 5 years savings & you start trading with 10 Lakhs capital.
Everything looks rosy but wait...before you actually start trading, have you asked these questions to yourself -
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 How will I use this money to yield the right returns for me?
 Do I know how much to allocate for investment & how much for trading?
 If I lose all, would I pump more money without changing any process?
 Should I trade in cash or F&O?
 Which all instruments I am going to trade?
 How much profit (%) I expect from each trade?
 How much money (%) I am willing to lose in each trade?
 What is my trading personality? (Scalper, Intraday, positional or very long term investor)

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These are just few eye opener questions which a person should ask to self first how he/she would use this money to achieve
his/her goals. Without knowing this, it is likely that the money deployed wouldn’t be used wisely & will be lost soon to those
who know these concepts better.

So what should you do?

The answer is simple – Diversify your overall capital

Diversification is an art which helps you achieve 2 goals-

1. Helps diversify your overall risk between various instruments & types of trades
2. Helps explore/try more Options & increases your probability of winning

The diagram on next page will help you understand what I mean by Diversifying Capital. Have a look -
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 DIVERSIFYING CAPITAL

Capital
10,00,000

Trading Investment

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500,000 500,000

Cash
Intraday Swing
Portfolio
200,000 300,000 500,000

Cash F&O Cash F&O Stock 1 Stock 2 Stock…n

100,000 100,000 100,000 200,000 50,000 50,000 50,000 each

SPLIT YOUR INVESTMENT CAPITAL EQUALLY INTO 10 OR 20 STOCKS WITH EACH HAVING A FIXED % OF RISK.
THE ABOVE SHARED IS JUST AN EXAMPLE & YOU CAN MODIFY IT TO SUIT YOUR CAPITAL, RISK APPETITE,
STYLE OR CHOICE OF INSTRUMENTS OR SEGMENTS YOU WOULD LIKE TO TRADE.
THIS MODEL IS VERY FLEXIBLE!
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 RISK MANAGEMENT
Now that we have fair understanding about how to use or split your money by using Money Management principles,
let’s learn how to manage RISK on this money via Risk Management :

We all know that trading is a game of probabilities & possibilities. There is always a 50-50 chance to win or lose. It
means that we risk some money to make some money. Right? So in simple terms, whether it is an investment or a
trade, both can go wrong & when we are wrong, we lose money. If we continuously lose money, our chance of

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survival goes thin & our probability of giving up on markets goes higher.

Therefore, RISK MANAGEMENT plays a vital role to help us manage our risk well. Below are some principles which I
have learnt hard way during my trading tenure & I believe these best practices can help you manage RISK well:

 Define % you will lose on each trade in trading & investing. Both required different level of planning
 In trading, set 1% risk rule for standard trades & 2% risk rule for high probability trades
 In investment, set 2-10% rule based on your expected return and/or trading setup
 Target minimum 1:2 risk reward. More the better.
 Define how you will hedge your position for overnight risks (Use Call or Put protection)
 Define how will you lock profits (Via Options)
 Use Stop Loss in every position. No mental SL please & it should always be in the system. As soon as you Buy or
Sell, you make a habit of placing SL immediately. No delays please!

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 RISK MANAGEMENT CONTINUED……
 Do not chase PRICE & avoid being caught in FOMO (Fear Of Missing Out). On a bus stop when one bus goes the
next bus comes. In trading one trade goes, next comes. Still, if you don’t want to miss a trade, deploy 50% capital
but use the same SL because SL doesn’t change. You can add 50% more on pullback & keep the same SL.
Bottom line is SL doesn’t change, your position size change.
 Trade in liquid stocks or Options where volume is good & the spread is tight. This will help you get out easily when
needed.

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 Avoid stocks which works on circuit. You will love when there is upper circuit but the day lower circuit starts, you
will cry to get out but you wont get an entry.
 Have a plan, rock solid plan to trade volatile markets. If you do not have a plan, better stay away because normal
rules doesn’t get applied in Volatile markets. Since swings/ranges/movements are wider, you have to widen your
SL as well else they are prone to get hit quickly. Reducing position size can help.
 Keep your emotions under control. Where there is money, there will be emotions. Bigger the money at stake,
higher the emotions. If taking an overnight position is not letting you sleep properly, it is highly likely that you have
taken an oversize position & you have BIG fear of losing. Reducing the quantity by 50-75% will help you feel
better.
 In intraday never open more than 5 simultaneous positions at any given point of time. Recommended open
positions are 3 max. Also max 2% loss on trading capital is allowed across all these 3-5 positions.
 Define your per day maximum risk capacity. In my opinion it should NOT exceed 2% of your trading capital. It
means that either you hit with 2 consecutive SL of 1% each on a day which wipes 2% of your trading capital or in
1 high probability trade you lose 2%, you should stop trading for the day.
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Let’s take an example of 1% risk per trade:
Capital = 100,000
Max risk = 1% (1,000)
You buy a stock at 100 with SL as 98 & target of 104 (1:2 Risk Reward)
Quantity you can buy => Risk / SL points
1000 = 500 qty.
2 (100-98)

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Let’s say your SL is 5 points & you still want to take this trade with a target of 110 (1:2 Risk Reward)
1000 = 200 qty.
5 (100-95)

Similarly, if you want to enter a Breakout trade & if SL is very wide then deploy only 50% of your capital instead of full
100% & deploy remaining 50% on the pull back to EMA21. SL remains the same. Here is an example –

A B C D E F
Capital Max Risk Average Buy Price SL SL Points (C-D) Quantity (B/E)
Position 1 50000 500 100 94 6 83
Position 2 50000 500 97 94 3 167

In reality, people change SL points but never change the quantity thus making more losses than expected.
Every trade looks positive unless it hits your SL so never be over confident on any trade & be realistic that it can hit
your SL anytime.
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Hope the examples shared helped you to understand how to manage your risk. You can tweak these % as per your
comfort level. I took 50-50% example but you can use 40-60% or 25-75% based on your comfort.

In a nutshell, our goal is to become a profitable trader or investor & if we follow the right principles of Money
Management & Risk Management, we can achieve this goal. Let us now understand the journey or various stages of
a trader/investor -

1. Loss making stage

a) Big losses

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b) Small Loss
2. Preserving capital
3. Profit making stage
a) Small Profits (Sometimes)
b) Small profits (Consistently)
c) Big profits (Sometimes)
d) Big profits (Consistently)

As a trader you have to transition from 1a to 3d & gradually pass all these stages 1 by 1. There are no shortcuts to
hop stages. For new traders I advise to trade in cash, trade less & be consistent in following process. Once you are
able to preserve your capital first then start thinking about getting small profits & gradually move towards big profits
by being consistent in your approach. Discipline & patience is the key to success here.

Hope this article was helpful. Do share your feedback on @PAVLeader twitter handle. Thanks for reading!
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