Account Equity

 

In simplest terms, the Stop Loss System ties together your account equity, the risk you’re willing to take per position, and the volatility of the underlying security. It takes these three inputs and calculates an appropriate stop loss and position size. Effective risk management is as much about stop placement as it is about using the right position size.

Your account equity is the simplest input into the Stop Loss System. It’s simply the amount of money you have in your account. But you must decide how you’re going to divide up your account equity into individual positions. That’s the first step of building the Stop Loss Strategy.

The amount of money you have to work with is a very important consideration that a lot of traders and investors overlook. You have to understand how the size of your account fits with the other components of a successful trading or investing approach. The size of your account will determine how and what you trade, how many positions you can carry at once, how diversified you can be, and the amount of risk you can afford to take in any given position.

A trader or investor with a $5,000 account will operate a lot differently than an individual with $500,000 to work with. An individual with a smaller account size will care a great deal about commissions and other transaction costs. A smaller account size, in fact, requires an attempt to minimize these costs.

Account size is relative to each individual. What is a small account to one person may be a large account to another. But no matter your account size, you want to try to minimize the costs associated with trading and investing.

A common mistake among traders and investors is over-trading. Buying and selling for the sake of doing something is often preferred over buying and selling for the sake of making money. Never lose sight of your goal: making money in the market.

Two big steps towards making money in the market are reducing commissions and minimizing losses. It’s false to think you need to trade a lot and take on big risks, especially if you have a relatively smaller account. But just how often should you buy or sell? When answering this question, we strongly encourage you to let your profit and loss be your guide. Don’t tinker with too much if you’re making a lot of money in the market. But take a long and hard look at your overall approach if you’re losing money in the market.

Your frequency of trading can vary a lot based on your entry rules, time you’re committing to the market, and overall approach. But you can narrow down how many positions you should be in based on your account equity. You might hold fewer positions if you have a smaller account. You might hold more positions if you have a bigger account. Use the following guidelines to get an idea of how many positions you might carry based on your account equity. (See Table 1.1)

Account Equity ($)

Number of Positions

  

5000

5

50000

10

500000

20

Table 1.1 – Number of Positions

Think of each position as a slice of the account equity. You’re dividing up your account into equal parts. Doing so will help you to establish consistency in the amount of capital that you commit to any given position. You want to work towards consistency in all aspects of your trading and investing. This step helps you be consistent in determining how many positions you might be in at any one time based on your account equity.

Dividing your account up into equal parts also helps you to achieve diversification. This is an effort to spread risk across your account in different positions that move independent of one another.

From here, we’ll be using a $50,000 account and 10 positions to illustrate concepts and strategies. This will give you perspective and context as you learn the system. The concepts and strategies are scalable across different account sizes, but we’ll stay consistent in the examples so that you have an easier time relating the concepts and strategies across different accounts sizes.