Position Sizing In Trading
Strategy, Planning and Risk Management
When you build a trading strategy, a lot of time and consideration has to be given to the essentials:
- Which asset class to trade
- Whether to buy or sell that market
- At what price to enter the trade
- What a sensible target level is
- Where to place a stop
Cutting across all of these is the essential issue of risk management.
Position sizing is an important technique to control it.
Position sizing means deciding the amount or size of the position you’ll take in any trade or investment. Correct position sizing helps you manage risk before you even enter a trade by ensuring that the amount you could potentially lose is within your risk tolerance levels.
See how experimenting with a Hantec Markets Demo Account can help you understand your risk tolerance before starting to trade.
As a guideline, most professional traders look to risk no more than 1% of their trading account on any one trade. You may wish to set up further rules for your risk tolerance, for example, not risking more than 2% of your assets under management (AUM) or a trading account on any one day. But the 1% guideline is a good place to begin.
If you exceed this amount, stop trading and evaluate. You might even go further and have weekly and monthly risk tolerance percentages relative to your AUM/ trading account size, to ensure that your capital doesn’t suffer aggressive drawdowns.
So how do you decide on your position size for any trade? Start with your trading account size. If you have $10,000 and risk tolerance of 1% per trade, then you could afford to risk, (e.g. lose), $100 on a trade.
The next step would be to do more analysis, decide what asset to trade, and whether to buy or sell. Then critically, you would determine an entry-level for the trade and also a stop loss. The difference between the entry point and the stop loss level is the possible risk in terms of either pips, cents, dollars or index points, depending on the market that you’re trading. From this, we can calculate the position size of the trade.
Let’s say you are willing to risk $100 on a trade and looking to enter long on Crude Oil (US Oil on Hantec Markets), buying at $50.00 with a stop loss set at $49.50. This is a potential loss in cents/pips terms of 50 cents.
- If you are willing to lose $100 on the trade and the pip cost in $1.0, then you could have a position size of $2/ pip or cent.
- If you entered long at $50.00 and the US Oil market fell to the $49.50 stop loss level, you would lose 50 cents on the trade, multiplied by your $2 per cent position size, which would be $100 and in-line with your risk tolerance (1% of your $10,000 AUM in your trading account).
Don’t neglect risk management.
Correct position sizing is vital to success in trading. First, establish a set risk tolerance percentage that you are willing to risk on each trade. Then you can establish the pips, cents, dollars or index points to risk on each individual trade. Based on risk tolerance you can then define your position size.