Measuring Your Risk | Podcast Episode #266

0:07
Hey, I’m Ryan Mallory, and this is my swing trading the stock market podcast. I’m here to teach you how to trade in a complex, ever changing world of finance. Learn what it means to trade profitably and consistently, managing risk, avoiding the pitfalls of trading, and most importantly, to let those winners run wild.

0:25
You can succeed at the stock market, and I’m ready to show you how. Hey everybody, this is Ryan Mallory with Swing Trading the stock market in today’s episode’s gonna be a good one. We got a lengthy email from a guy that we’re going to call, Chester. Now, Chester is actually a dog that I had growing up.

0:41
I actually didn’t like the dog too much, but Chester, I think he ended up getting lost one day and we never saw him again. But anyways, this guy we’re gonna call Chester, it’s a good Florida redneck name, also apparently a good name to name your dog. No, no offense against the guy who wrote the email. I’m not basing it off of that.

0:58
But any case, Chester writes, Ryan, I’ve been following your podcast and also a subscriber for a while now. I really appreciate what you do and offer for the community. My question is about risk. As my account has ebbed and flowed over the past two years of genuine effort at trading, unfortunately, not just straight up.

1:14
I’ve gotten into the habit of taking the same position, size and risk percentages. That is until recently when I took some money out of my brokerage account to cover some other expenses like a down payment on a bottle of Blanton’s. Just kidding, he writes. That didn’t actually happen.

1:30
And realized that this withdrawal was significant enough to change my risk calculations and therefore should go back and change my position sizes or math. I had gotten so much into the habit of the same math based on The account size that I was trading with, I had to go back to the books to buff up some facts and standards of risk management.

1:48
It was at that point I asked myself, what would Ryan do? or more specifically, what does Ryan do? After thinking about that for a second, I have realized that I don’t think I can point to exactly how you define risk beyond the tongue in cheek response of how much money would we try to not lose. I think you touched on this a few episodes ago, but didn’t not get to it succinctly enough to answer my question that I thought I would ask it more specifically.

2:09
We talked a lot about managing risk, but what does that Mean in terms of what are we exactly managing a percentage of our overall account, a hard dollar amount associated with a pain threshold, and overall position size based on a dollar amount or percentage of our account, a risk reward ratio maybe.

2:26
I have traditionally viewed risk as. A few distinct pieces. Number one, the amount that I have at risk between my entry and my stock price versus the total number of shares. For me, this is a dollar amount and threshold of pain. That is if my stop loss hits, this is the total amount that I’m willing to lose.

2:44
Coincidentally, this number also represents 1% of my total account value. I try and manage the total dollar amount associated with the whole position size. I believe the standard is 8% of your total account value. However, I often find myself at a larger percentage than that around 12% or so, but I am comfortable with a larger percentage based on the stops that are always in place.

3:04
It also makes my calculations easy if I am able to calculate one position block size. When necessary, I’ll always. To a smaller position size to keep my stopwash threshold within tolerance and in line with realistic resistance levels on the chart having a stop loss based off of my pain threshold.

3:21
But reducing the position size too small starts skewing reward ratio too much and the possible trade quickly becomes not worth the potential reward, correct? Oddly enough, when I do the math with your trade setups, entry and stops, my #1 and 2. Criteria are usually met. So I don’t think that I’m too far off base.

3:37
Maybe I’m just looking for validation or a better explanation of how you do the same calculations and some other norms or ways to do the same. Similarly, when you put out a trade setup, you give a risk number. What does this represent and how do you calculate it? He’s talking to him about my risk rating that I provide on all my trades.

3:53
He goes on to say tonight I’m drinking Old Forester in 1813. Which is a rare one at my local store, but it’s just on the expensive side for an everyday sipper, but I don’t think you have reviewed Basil Hayden yet either, which is my go to. Also, what are your thoughts on prop firms, scam or some legit?

4:10
Thanks for the explanation. Chester. Now, before I get any further, I’ve been dying to get my hands on 1913. Old Forester bourbon is some of my favorite bourbon out there. I wish I could get my hands on a birthday bourbon. I wish I could get my hands on the 1913 or any of these other ones that aren’t like the 1870, 1897, 1910 or 1920.

4:30
So if you guys come across it, email me. I will Venmo you to send this to me. I really want it back. So yeah, if you see it, let me know. OK, guys. What am I drinking today for this podcast? I am drinking and you guys might like this one. This is benchmark small batch.

4:46
I’ve been meaning to try this one out because I think I only paid like $17 for this bottle at Total Wine. It’s 45% alcohol, it’s 90% proof. Again, small batch, and it’s made by the Buffalo Trace Distillery, and a lot of people really like it. And I’m kind of excited about trying.

5:02
Now, this is gonna be my 2nd time trying it and the reason why it’s my 2nd time is I like to do an initial taste because when I initially pop the bottle open, it’s not always what the ultimate taste is going to be like. It oftentimes helps to let the bottle sit out for like 15 minutes, but I still like to get that initial taste.

5:17
I just can’t wait 15 minutes. So I’ll usually try it. But oftentimes I’m not impressed with that initial taste. Now, this is my 2nd go around. And let me tell you, it smells better. Than the first time around. The first time around, I couldn’t pick up any taste. This one actually has like a little cookie dough smell.

5:33
It’s pretty cool, very sweet smelling. And then to the taste that you got like caramel and you got vanilla, I mean, really nice. The only thing I would say about it is that it doesn’t really last long enough. If it was a half second to a second longer, it would be amazing. Little bit of spice there at the end.

5:49
I would say the finish to. It is probably the most unflattering aspect of this bourbon. On a scale of 1 to 10, and this is a hard one. It’s definitely an everyday sipper. I think you can drink it on the weekends you want. It’s really not bad. I’ve not tried it with old fashion yet. I typically I like my old fashion with 100 proof.

6:05
I can’t give it a 6.something and I can’t give it well into the sevens. I’m going 7.0. I think that’s a fair, look, 7.0 for a bird. that costs $17. That’s a steal. Now, they also have foolproof, which I heard is the best of the benchmark series.

6:21
I’m gonna try that one here in the future. I’ll probably run out this upcoming weekend and get some of it because the small batch was impressive. I didn’t like it at first. I thought it had zero taste the first sip that I took when I initially opened it up, but I let it sit for a few days, and when I opened it back up, it was.

6:37
Full of flavor. I mean, really just an impressive bourbon for the price. I don’t think it’s up there with Old Forester. I don’t think it’s up there with any of the, you know, really good ones that I’ve reviewed, but for the price, you’re gonna be hard to beat the taste for the price. So again, that’s benchmark small batch.

6:54
It’s made by McAfee Brothers, distilled by Buffalo Trace, I give it a 7.0. And we got a pretty lengthy email here and there’s a lot to talk about. I think I can get this in under one podcast episode. But he has all sorts of questions about measuring risk and this really came after he had to withdraw some money from his account.

7:13
He had to recalculate how much he traded in the stop losses that he used, etc. And he mentions in the email that I’ve often referred to. The idea that your position size shouldn’t be anything more than what you’re willing to lose, and that’s a very like surfacey explanation, but we’re gonna dig deeper into that with this episode.

7:30
But risk really comes down to a position size measured with your stock loss that won’t affect your judgment when determining when to buy or when to sell a stock. So, for instance, If you trade a huge position size, let’s say you have a million dollar account and you’re trading $500,000 on that trade, and you’re down 10%, it’s going to affect your judgment.

7:53
You’re gonna make bad decisions and you’re probably gonna panic sell cause you just lost $50,000 especially if it’s like inherited money that you just got and you want to go right into the stock market. And believe me, people do do this, and they’re not. used to seeing those kinds of swings in the market. Yeah, it’s going to affect their judgment.

8:09
Now, the other thing I would say is that you can have a decent position size, but a far too big of a stop loss. Let’s say that you have a $100,000 account and you’re trading with a $5000 position. You’re only risking 5% of your capital total in terms of position size.

8:27
But then you have a stop loss that’s 50% and you’re trading like a penny stock, and now all of a sudden the stock gaps down 50%, which is very possible with penny stocks, and you’re down $2500 or 2.5% on your account, and you can’t handle the idea of losing $2500 on your $100,000 account and so you panic sell out of it.

8:47
So you can actually have a small position size but too big of a stop loss or use a big position. and have a very small stop loss and it not affect your judgment. The only thing I would warn though about position sizes that are really big relative to the overall account, let’s say you’re really good with 1% stop losses and you’re trading with a million dollar account and you put $500,000 down on the trade.

9:10
But you’re saying, hey, I’m trading Walmart with a 1% stop loss. I’ve done this before, it works great. And that’s what this person tells himself. So, Stop losses hit, he stands to lose $5000. Small potatoes per se for a million dollar account, and he’s OK with that.

9:26
But then what do you do? Like what happened right before I started recording this podcast where Walmart comes out out of nowhere and does an earnings warning, plummets the stock 10%. So then all of a sudden, you’re not looking at a 1% decline on the stock. You’re looking at a 10% decline after hours that’s going to carry over into the next trading session and now instead of being down $5000 on the trade, you’re down $50,000 on the trade.

9:49
So a too big of a position size relative to the overall portfolio is not a good thing either because of headline risk, because of unknown risks, the risks that can happen that you’re not expecting. I’ve had this happen to me before too. I’ve had it happen to me. With Apple. Apple of all stocks. I remember like 4+ years ago, probably.

10:07
It was one of my first trades of the year, if not my first trade of the year, and Apple came out with lower guidance and my stock plummeted 7% overnight. Now, let’s say I was trading with 50% of my account, like I just using this example. Well then all of a sudden that 7% decline is a significant hit to the portfolio.

10:26
And so position sizes. That are really large carries a lot of risks still, even if your stop loss is tight because of the headline risk or the potential for risk. I mean, we’re seeing that all over the place here so far in this earnings season. And for those listening in the future, we’re talking about the second quarter earnings for 2022, and they’re guiding lower for the third quarter right now and into 2023 as well.

10:49
So you need that healthy balance between the stop loss that you use and the position size. So for me, I know he mentioned in this that I use like 8% of my total count. Usually my position sizes are about 10%. They can waiver a little bit, but for the most part about 10%. Now, I also use like a stop loss somewhere between 4 to 6% because those are stop losses that I’m comfortable with.

11:09
Sometimes it’s a little bit less that it can even be between 2 and 4% sometimes and I’m OK with that as well. It just depends on where the support is. Now, there’s a Theory or a train of thought that a lot of people use in terms of their trading, and I’m not a huge fan of it to where you willingly risk like 1% of your portfolio or 2% of your portfolio, whatever it is that a person’s comfortable with on every one of your trades.

11:30
So your position size is gonna be based off of how much it’s going to take for you to lose 1 or 2% of your portfolio if your stop losses hit. So that sounds really good on paper, but again, it goes back to, let’s say you’re using a 1% position size and it makes it to where you can have. like a 30 or 40% position of your portfolio on that particular trade and you have what just happened with Walmart today cause a massive sell-off.

11:52
And then all of a sudden it doesn’t matter what your stop loss was, you’re getting stopped out in a big way that goes well beyond your stop loss. So there’s a reason why I choose the position sizes that I do because at a 10% loss on 10% of my portfolio, yes, I will lose 1%.

12:09
There’s also a reason why I don’t trade penny stocks is because I can’t manage. that headline risk, I can’t manage that gap down risk. There’s also a reason why I trade a large number of large cap stocks and highly liquid stocks and stocks that don’t have a lot of headline risk. For instance, Boeing. I haven’t traded that stock in ages, years, and it goes back to the time when they were having these crashes and everything else.

12:29
It’s like every time I was trading it, there was another disaster that was unfolding, and I didn’t want to deal with that from a headline risk standpoint, so I haven’t traded it since. You also have FSLY which is fastly. Man, that’s another stock. I want nothing to do with because there’s always these crazy gap downs in the stock.

12:48
If you go back just even a couple of years, you will see some major gap downs. I’m like, I don’t want nothing to do with this thing. Then you have LL. I remember there was like a scandal with LL back in the day, the Lumber Liquidators. After that happened, I wasn’t long in it. I didn’t have any positions in it, but I was like, I’m not playing that stock ever again, and I haven’t.

13:04
I actually keep a list of stocks that I will not trade and sometimes I should probably reevaluate. Evaluate the stocks that are on there and consider whether or not I should take them off, but for the most part, once they get on there, they stay on there for a very, very long time. And those are just a few of the ones that are on there.

13:19
He asks a good question too about what are we actually managing when we manage risk? Well, we’re trying to keep the losses manageable because, gosh, that sounds bad, but we are, we’re trying to keep losses manageable. I always go back to, I want to win slow and I want to lose fast. I want to get out of a trade as soon as possible.

13:36
I don’t want to stay in it forever. And yes, that means that sometimes I’ll be stomped out and the stock will go right back up and I’ll like, crap, which I didn’t get stopped out of that trade. But my profits will only be as good as how I manage my losing trades. If my losses are out of control and they’re outsizing my profits, it doesn’t matter how many good winning trades that I have, my losers are just horrendous.

13:55
It doesn’t matter. So you gotta keep those losers tight. You don’t want one single trade. To affect your entire year of trading or even your career in trading. You see it all the time with hedge funds. They take these outsized positions in these stocks. They’re shorting them and all of a sudden they get squeezed. You saw it with the whole GameStop phenomenon. Yeah, sure.

14:10
I think that stock is trash. I don’t think it’s going anywhere. But I wouldn’t be shorting into margin on that thing because anything can happen. There’s another example of RDBX. People want to short that stock. Yeah, Redbox. Who the heck even goes to Redbox anymore? I’m sure there’s some of you guys that probably go there from time to time, but in general, people are streaming.

14:28
And yet people are buying this thing, and they’re sending it up 100% in a single day. Why? I don’t know. Do I think it’s stupid yet? Do I think it’s gonna go down? Yeah, but it doesn’t necessarily mean I want to short it because of the headline risk. And the fact that I short it, I stand to lose a lot of money. So what are we managing? We’re trying to keep losses manageable.

14:45
We’re trying to keep them small. We’re trying to keep it tight. We talked about the Walmart issue where they’re coming out with lower guidance, and that has created a significant selloff in the stock. That’s headline risk. So even though we can’t always predict where the headline risk may exist, we can’t predict when a stock wants to.

15:04
Guide lower just out of the clear blue, can’t do nothing about that. That would be insider trading anyways and we’re not privy to that either way, but we have to guard against it. We have to guard against the fact that the stock, the company could come out and guide lower. So we have to make sure that our position size is such that, let’s say if it was catastrophic, let’s say a 10% position size.

15:24
Suffered a 50% loss. Would that suck? Absolutely, it would be awful, but would it define my ear? It would put a dent in it, but it wouldn’t destroy it. So you have to think about that in terms of worst case scenarios. And position sizes can change over time.

15:40
You can become more comfortable with more money at risk. You may become less comfortable as your portfolio grows having the same kind of position size that you would when you were trading with a much smaller position. So maybe instead of like 10% when your account doubles, you’re all of a sudden using like a 5% position size and that’s OK too.

15:57
Again, we’re always going back to what we’re. Comfortable with in our trading and what we can withstand from a trading style that we’ve incorporated into our strategy how we can manage those losses appropriately and we can’t think for a second that just because the stock doesn’t have a history of headline risk that it can’t have headline risks.

16:14
So you take a stock like Walmart, there’s only been 11 times since 1985 where the stock has dropped or gap lower by 7%. 11 times. That’s essentially over a period of 37 years. This year alone, there’s been two instances of that. So going into this year, I think to yourself, OK, 9 times over the last 5 years, not really worried too much, but then you get into 2022 and it’s a bear market and all of a sudden you have two of them.

16:37
That happens in a single calendar year and we’re only 7 months in. So you have to guard against headline risk and you don’t want to take these outsized bets, even if it feels like it’s the safest of all stocks. And one thing that you should definitely consider doing is subscribing to swingtradingthestockmarket.com.

16:52
I’ve actually made a lot of changes to this here in the past week or so. I’ve incorporated videos, videos, I say, into swing trade in the stock market. I have some private videos that I share with the members of Swing Trade in the stock market where they’re now getting even more updates on like the Fang stocks and on some of your big tech plays that also includes market updates, plus weekly.

17:11
Watch lists that I’m following for both Bullish and Bear stocks and the setups that I’m looking at each and every day. So check that out, swingtradingthestockmarket.com. I think you’re gonna like it and you’re supporting this podcast in the process. Now, before we wrap this up, there’s a few more things that I wanted to talk about. He asks about the risk rating.

17:26
What do I calculate on my risk rating? Well, what I judge in my risk rating is a couple of things. First of all, I’m looking at the headline risk like what we talked about, that’s going to cause a Risk grading to go up, it’s based off of a scale of 0 to 5. I’m also looking at the volatility like the beta of the stock. How much does it move relative to the overall market on a day to day basis?

17:44
If it has a beta of 2, meaning that it usually doubles whatever the market does, it’s gonna have a higher risk rating because if I’m wrong on the trade, a gap lower in the market could result in a much bigger gap lower for that particular stock. I’m also looking at the sector, the industry, and also market conditions. The overall market conditions are bad and I’m trying to get long on a stock.

18:01
It’s a bounce play or whatever. It could have a higher risk rating. So all those things go into my risk rating and what I consider when looking at a trade. Also, the stop loss, if I’m having to use a little bit wider stop loss or at the top end of my threshold for what I’m comfortable with, which is around 5 or 6%, then yeah, it’s gonna have a higher risk rating.

18:19
If it has a stop loss of 2%, it’s gonna have a lower risk rating. And then he asks about the pro firms. Do I think that they’re scammish? Do I think they’re legit? I would say most of them are scams. I’ve come across very few of them and I don’t even remember which ones they are because there’s so few of them, and over the years I’ve maybe come across one or two that seem legit, and I can’t even verify if they are.

18:39
I would always assume, especially if they’re offshore, always assume the offshore ones are scammish. There could be some good ones out there, but I would always assume those suckers are scammish. They don’t hold your best interests at heart for the most part. You lose money, yeah, they like to leverage your money, give you some of their money to be able to trade with, but in the end, if you lose, it’s coming out of your pocket.

18:59
So I think firms are really just a shortcut to getting rich quick and in the stock market, we should never approach it with that kind of attitude. It should be a journey of consistently managing the risk on every one of our trades and maximizing our profits along the way.

19:16
If you do that, you’ll never need a problem, especially in this environment here where we have zero commissions. So, keep that in mind. Make sure if you like this podcast, to leave me a 5-star review, whether it’s on Apple, Amazon or Google or any other platform that you’re listening to.

19:31
It does mean a lot to me. It helps me out, helps me jump up on the rankings, so I always Appreciate those 5 star reviews and make sure to keep sending me your emails, ryan@shareplanner.com. I’m hoping for Chester’s sake, I answered most of his questions. And again, if you guys come across some of that 1913 Old Forester or the birthday bourbon, let me know.

19:52
I would be more than happy to compensate you guys for that. So take care and God bless. Thanks for listening to my podcast, Swing Trading the stock market. I’d like to encourage you to join me in the SharePlanner trading block where I navigate the stock market each day with traders from around the world.

20:09
With your membership, you will get a seven-day trial and access to my trading room, including alerts via text, email. And WhatsApp. So go ahead, sign up by going to shareplanner.com/tradingblock. That’s www.shareplanner.com/trading-block, and follow me on SharePlanner’s Twitter, Instagram, and Facebook where I provide unique market and trading information every day.

20:31
If you have any questions, please feel free to email me at ryan@shareplanner.com. All the best to you and I look forward to trading with you soon.