Adrian Reid breaks down three types of trading risk: losses on single trades, individual stocks collapsing, and broad market crashes. He recommends risking under 1% per trade, keeping any single position to 5-10% of your account, and sizing your total exposure so you survive a 20% overnight market drop. The point is staying solvent long enough for an edge to compound.
Questions this video answers
Less than 1% (many of his systems use ~0.5% or less).
$100.
100 shares (risk = $1 per share × 100 = $100).
Keep the dollar value invested per stock to about 5–10% of the account.
About 20% overnight.
This comes closely. The answer to this comes close off the back of the previous question about how to enter an exit is you need a consistent approach to managing your risk. Risk comes in a couple of different forms. There is the risk that you might be wrong on this trade you buy, but it actually goes down that stock specific risk.
There's also catastrophic stock specific risk risk where you buy a stock and it doesn't just go down, it collapses and the company goes bust and you lose the whole thing. That's a much lower chance of happening, but a much higher dollar impact. So there's normal stock specific risk and catastrophic stock specific risk. And then there's market specific market catastrophic risk where, okay, I'm invested in stocks and the market crashes and my whole portfolio goes down with it. There's three levels of risk that you want to think about when you're managing your risk in trading. So how do we manage it across those three levels of risk? Well, the first thing we're going to do if we think about stock specific risk, if we're wrong on this trade, we want to make sure that we lose a very small proportion of our total trading capital. Because you could be wrong and will be wrong many times in a row. And if you're right 50% of the time and you're wrong 50% of the time, it's like if you flip a coin. If you flip a coin, the chance of getting a losing streak of many trades, five, ten trades long, there's actually a reasonable chance of getting a 5 or 10 coin flip losing streak. And if you're trading, the chances are similar. You know, you can get a long losing streak of trades. So you've got to make sure that when you're wrong, you only lose a very small amount so that your capital doesn't get completely eroded by a string of losses. So you manage your stock specific risk by putting only a small proportion of your account at risk on each trade. How small? Less than 1%. So if you're wrong on the trade, you should lose less than 1% of your account on that trade. It doesn't mean you take 1% of your account and you put it into that stock. So let's say to make the numbers easy, you, you have a $10,000 account. One percent of that $10,000 is $100. You don't take $100 and invest $100 in each stock. What I'm talking about is if you buy a certain amount of stock and it goes down a little bit, you have a stop loss that Gets you out. So let's say the stop loss gets you out. You buy at $10 a share, and the stop loss is at $9 a share, okay? So if you have a $10,000 account, you're risking 1% of the account on each trade. That means you, if you're wrong, you only want to lose 100 bucks. If you buy at $10 a share and your stop loss is at $9 a share, that's $1 per share that you will lose on that trade. If you're wrong, $1 a share, you can afford to lose $100 because that's the 1%. So you can only buy a hundred shares of that stock, because that way, if you buy it at $10 a share and it goes down to $9 a share, where your stop loss is, you'll lose your hundred dollars, the 1% of your account, and it's not going to be so much that it really hurts you. So that's how you manage stock specific risk, keeping the losses on each trade very small. When you're beginning and you've got a small account, it's going to be hard to risk such a small amount. So you might have to start with with 1 or 2%. As your account grows, you want to risk even less. So most of my systems are risking about half a percent of my account or less per trade. That way, it doesn't matter if you have a losing trade, it doesn't matter. You just get out. You move on to the next one. No big deal. Stock specific risk. Catastrophic stock specific risk is this small chance that something extreme could go wrong. Now, let's say you've got a $10,000 account and you get a really hot tip from an inside source that this company is going to the moon, and you put your whole $10,000 in the account, and it turns out that that company was a fraud, and it gets delisted and goes to zero. How much of your account have you lost? All of it. So we have to think about the very small chance of losing the entire investment in that stock. And so the way you manage that is not by avoiding the market altogether. It's by making sure that the size of your trades, the dollar value, is not that big. So if you're wrong and it hits your stop loss, you might lose 1%. But you want to make sure that the total dollars invested per stock is less than, say, 5 or 10% of your account. So if there's a catastrophic loss once in a thousand trades, it doesn't wipe you out. Or it doesn't even hurt you so much that you have to lose sleep over it. Yes, it's annoying, but it doesn't kill you. Good. So that's catastrophic stock specific risk. And then you've got market risk. Market risk is if you think about your whole portfolio. If there's a dislocation in the market, what should you know? How do I manage that? Because let's say you've got a $10,000 account and you use a whole lot of leverage. This is back to the forex issue of why so many forex traders blow up. Let's say you've got a $10,000 account and you take on a lot of leverage and you buy $50,000 worth of stocks. Okay. Believe it or not, you can actually do that, depending on which broker using.
And the market collapses 20% overnight because war breaks out, new pandemic, you know, dirty bomb goes off in New York, whatever, right? Market collapses 20% overnight, you can't get out. If you're leveraged that much, you walk away with nothing but debt. You owe your broker a fortune. So to manage market catastrophic risk, you've got to make sure your total exposure is such that if the market collapses overnight, say 20%, which is possible, it's happened before. If the market collapses 20% overnight, you can live to trade another day. So three levels of risk management will keep you in the game. And by staying in the game and having a system that is profitable over time, over time you build wealth and you don't get wiped out. That's how you manage risk when you're trading stocks.
