You need a simple method for determining how many shares of a stock to trade. This is not something that is usually found in most trading systems. However, it is essential money management.

To figure the number of share, your trading system must provide you with your total trading equity and your stop loss.

Next we need to determine how much of the equity we will place at risk. Now, this is not the total cost of the shares but rather how much you are willing to lose. Suppose you start with $100,000. Your equity is the $100,000. Let’s begin by risking only 1% of you starting equity. Why 1%? A lot of traders, smarter than me recommend 1%. It means that you can make a lot of mistakes and still be in the trading game. I believe Larry Hite, trader extraordinaire, said that trading more than 2.5% of equity make you a gunslinger. Using a higher percentage will make more money if you are right, but it will permanently put you out of the game when that inevitable string of losses occurs.

  Everyone must determine their own risk factor

To repeat, 1% of $100,000 equity does not mean you purchase $1,000 of stock. That means the maximum you are willing to lose $1000. Now, we need to decide where we will get out of the trade if it goes against you. That is decided by your trading system. For example, you buy Wal-Mart at 45. You system says get out at 40 or a 5 point loss. If you decide to risk 1% of your account $100,000 or $1,000, then simply divide 1000/5 and get 200 shares of WMT. If you get fractional numbers round down to the nearest whole number. By varying when to close a position, you can see how the selection of your stops and starting risk affect your trading system.

Example

Account $50,000
Amount of portfolio to risk 1.5% ($750)
Stock Price 40
Stop 5% of stock price ($2)

Answer:

You buy 375 shares. You have a $2 stop and are risking 1.5% of equity.

In other words, if you purchase 375 shares and the stock goes down $2, you lost $750 or 1.5% of the portfolio.

Example
Account $50,000
Amount of portfolio to risk 1% ($500)
Stock Price 47
Stop 10% of stock price ($4.7)

 Answer:

You buy 106 or 100 (round to nearest whole number shares. You have a $4.7 stop and are risking 1.% of equity.

In other words, if you purchase 100 shares and the stock goes down $4.70, you lost $470 or about 1% of the portfolio.