Day 4 – Risk Management & Position Sizing: Protecting Your Capital



Introduction

By now, you’ve:

  • Understood stock market basics and set up your environment (Day 1)

  • Practiced trading with a mock portfolio (Day 2)

  • Learned to read charts and spot technical signals (Day 3)

Now comes the non-negotiable part of trading:

Risk Management — the art of losing small and winning big.

Many traders master chart reading but fail because they can’t control losses.
A single bad trade can wipe out weeks or months of gains — unless you follow strict rules.

Today’s goal: build a risk management system that keeps you in the game long enough to win.

Step 1: The Golden Rule – Protect Capital First

The first commandment of trading is simple:

“Don’t lose your trading capital.”

Not because losses aren’t part of trading (they are), but because without capital, there’s no trading tomorrow.

Think of your capital as oxygen — once it’s gone, the game’s over.

Step 2: Understanding Risk per Trade

Professional traders rarely risk more than 1–2% of total capital on a single trade.

Example:

If your trading capital is ₹1,00,000:

  • 1% risk per trade = ₹1,000 maximum loss.

  • 2% risk per trade = ₹2,000 maximum loss.

If you lose ₹1,000 on one trade, you still have ₹99,000 to keep trading.
Lose ₹10,000 in one bad trade, and recovery becomes much harder.

Step 3: The 2% Rule

The 2% Rule means:

  • Never risk more than 2% of your total trading account on a single trade.

It’s not about position size alone — it’s about combining position size with your stop-loss (we’ll cover that next).

Step 4: Stop-Loss Orders – Your Lifeline

A stop-loss is a pre-set order that closes your position automatically when the price hits a certain level.

Why use it?

  • Prevents small losses from becoming big losses.

  • Removes emotional decision-making when trades go wrong.

Example:

  • Buy a stock at ₹500.

  • Decide you’re willing to risk ₹20 per share.

  • Place stop-loss at ₹480.

If price drops to ₹480, your position closes — protecting you from a bigger loss.

Step 5: Calculating Position Size

Position size is the number of shares you buy. It’s determined by:

  • Your risk per trade (in money)

  • The stop-loss distance (in price)

Formula:

java
Position Size = Risk per Trade ÷ Stop-Loss Distance

Example:

  • Trading capital: ₹1,00,000

  • Risk per trade: ₹2,000 (2% rule)

  • Stop-loss distance: ₹20 per share

java
Position Size = ₹2,000 ÷ ₹20 = 100 shares

You buy 100 shares so that if the stock hits your stop-loss, you only lose ₹2,000.

Step 6: Risk-Reward Ratio (RRR)

Risk management isn’t just about limiting losses — it’s about ensuring wins are bigger than losses.

The Risk-Reward Ratio compares potential profit to potential loss.

Example:

  • Risk: ₹20 per share (stop-loss)

  • Target profit: ₹60 per share

  • RRR = 60 ÷ 20 = 3:1

A 3:1 ratio means you can be wrong more often than right and still make money.

Step 7: Surviving Losing Streaks

Even the best traders face losing streaks. Risk management keeps you alive during these periods.

Scenario:

  • Risk per trade: 2% of ₹1,00,000 = ₹2,000

  • Lose 5 trades in a row → Total loss = ₹10,000 (10% of account)

  • Still have ₹90,000 to recover.

If you had risked 10% per trade, 5 losses would leave you with just ₹59,000 — recovery becomes nearly impossible.

Step 8: The Emotional Side of Risk Management

The main reason traders break risk rules is emotion:

  • Greed: Increasing position size after a win.

  • Fear: Moving stop-loss farther away to “give it more room.”

  • Ego: Refusing to accept being wrong.

To combat this:

  • Pre-plan every trade before entering.

  • Use automated stop-loss orders.

  • Review every losing trade without self-blame, only with analysis.

Step 9: Scaling In & Out

You don’t have to enter or exit trades all at once.

Scaling In:

  • Enter with partial position, add more as trade moves in your favor.

Scaling Out:

  • Take partial profits at your first target, let the rest ride with a trailing stop.

This approach reduces risk while allowing profits to grow.

Step 10: Day 4 Practice Plan

Today, you’ll:

  1. Pick 5 stocks from your mock portfolio.

  2. For each:

    • Set risk per trade = 2% of your total account.

    • Decide a logical stop-loss (based on support/resistance).

    • Calculate position size.

  3. Determine a minimum 2:1 Risk-Reward Ratio before entering.

  4. Record everything in your trading journal.

Common Mistakes to Avoid on Day 4

  • Risking more after a win: Stay consistent.

  • Not respecting stop-loss: Your first loss is your smallest loss — if you take it.

  • Ignoring position sizing: Even a great trade idea can blow up your account if oversized.

Your End-of-Day Review Questions

  1. Did I stick to my pre-decided risk per trade?

  2. Were my stop-loss levels logical (based on chart structure)?

  3. Did I calculate position size correctly?

  4. Was my Risk-Reward Ratio at least 2:1?

Preview of Day 5

Tomorrow, we go deeper into Advanced Technical Analysis:

  • Fibonacci retracements

  • Trend channels

  • Chart patterns like triangles, flags, and head & shoulders

  • Combining indicators for high-probability trades

This is where your trading starts to look professional.

Final Thought for Day 4:
Great traders don’t win because they predict the market perfectly — they win because they control losses when they’re wrong and maximize gains when they’re right. Risk management is your seatbelt in the fast car that is the stock market.


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