TRADING MATHEMATICS

TRADING MATHEMATICS

What “Trading Mathematics” is all about

Trading the market involves dealing with money.  Money is measured in numbers.  Much use is also made of charts and trendlines.  This too involves numbers.  Risk management involves numbers.  Once a trader understands what trading is all about, a clear picture of the inter-relationship between various facets, like price, volume, and other variables will appear.  Trading mathematics is simply documenting these inter-relationships between the various items.

Getting Started with Trading Mathematics

1 – Memorise the Variable Names.

For example, memorize the name “Stop Loss Price” and understand what it means.  Memorize the name “Purchase Price” and understand what it means.

2 – Memorise the Acronyms

For example the acronym for “Stop Loss Price” is SLP, and the acronym for “Purchase Price” is PP.

3 – Understand and Memorise the Trading Mathematics Formulae

These formulae are all logical and not difficult to understand.  In fact, they are common sense, just expressed mathematically.

Trading Mathematics Variable Names Defined, Acronyms and Logic

CAP = Capital

CRP = The Capital Risk Percentage.   Normally 1% to 2%.

CRA, the Capital Risk Amount

CRA = CAP x CRP

Capital Risk Amount = Capital x Capital Risk Percentage

PP = the Purchase Price

SLP =  Stop Loss Price

MLPS = Maximum Loss Per share

MLPS = PP – SLP

Maximum Loss Per Share = Purchase Price – Stop Loss Price.

PC = Play Count, the maximum number of shares that you can buy to keep your total losses for this play within your Capital risk Amount, CRA.

PC = CRA / (PP – SLP) = CRA / MLPS

Do not take all your money and dump it into one stock.  Trading is a probability game.  You need to size your positions correctly.  Refer to a position sizing calculator that you set up in a spreadsheet.  A Day Trader must protect his downside.  The Day Trader’s capital must not hit zero.  Risk management is essentially about protecting your capital.  Proper Position Sizing will reduce risk.  Trades must be selected that make sense with ratios.  Look at the upside risk and the downside risk and the ratio between the upside risk and downside risk.  A good risk management strategy is the use of a Capital Risk Percentage of from 1 percent to 2 percent of the capital.  Perhaps beginners should use 1% and later move up to 2% of capital.  Call this the Capital Risk Percentage (CRP).  So if for example, a Day Trader has capital of $10 000 and if he selected to use a CRP of 2%, then he should not risk more than $200 (2% of $10 000) on any trade.  Call this amount the CRA, the Capital Risk Amount.

So, CRA = Capital x CRP.

Capital Risk Amount = Capital x Capital Risk Percentage.

In this example,

Capital = $10 000

CRP = Captial Risk Percentage = 2%

CRA = Captial Risk Amount = $10 000 x 2% = Capital x CRP = $200

So this Day Trader would only risk $200 per play because his CRA is $200.  The CRA is the maximum loss that you should be prepared to take on a trade.  In other words, the maximum that you should be prepared to risk on any single play is dependent upon the size of your capital.  The more capital that you have, the greater the amount that you can risk on any single trade.  The less capital that you have the less you can risk on any one single trade.

Assume that you buy a stock at PP, the Purchase Price.

Assume that you set a Stop Loss Price as well, called the SLP.  This SLP is set taking into account many factors, including support levels, SMA levels, key demand areas, and supply areas.

So, for every 1 share, you can loose up to PP-SLP, the Maximum Loss Per share, the MLPS.

MLPS = PP – SLP

Maximum Loss Per Share = Purchase Price – Stop Loss Price.

Say the shares cost $12.00 and you set the Stop Loss Price at $10.50.  So PP=$ 12.00. SLP = $10.50 .

Then MLPS = PP – SLP = $1.50

Given that you do not want to lose more than CRA, in this case, $200 per play, then you can only purchase $200 / $1.50 = 133 shares.

Define Play Count or PC as the maximum number of shares that you can buy to keep your total losses for this play within your Capital risk Amount.

So PC = CRA / (PP – SLP) = CRA / MLPS

In this case PC = $200 / ($12.00 – $10.50) = $200 / $1.50 = 133 shares maximum for this play to keep the maximum potential loss under the CRA, the Capital Risk Amount.

Trading Mathematics Formulae Summary