Position Sizing: Everything You Need to Know | My Espresso

A Quick Guide to Position Sizing

When it comes to position sizing, it can be pretty subjective. What is right for one trader might be too much for another. But make sure that you have proper risk management in place for it. There are many traders out there who randomly take up position sizing while trading.

Published on 24 February 2023

But the primary question is, “what exactly is position sizing?” Well, it’s the number of units in which an investor or a trader can invest within a specific security. A trader’s risk tolerance and account size should be carefully considered when determining Position Sizing.

How to Determine an Appropriate Position Sizing?

When it comes to position sizing in trading, you have to risk a minimum of 1% to 3% of a single trade. But when you’re a professional investor, it will be much better to try other position sizes, which will depend heavily on the specific investment you wish to make.

For instance: When you purchase a cheap and safe dividend stock, it will not be a bad idea to risk around 5% of the account. But when you’re dealing with all the traditional volatile vehicles like options or junior resource stocks, the smaller position size of 1% of an account will be appropriate.

Examples of Position Sizing

If you want a good understanding of position sizing, here are two important examples that will be helpful.

1.    The $10,000 Account Positing Sizing

 Let’s say you have $10,000 for trading. You decided you will have a maximum loss of $200 when you risk 2% of the capital on every trade. It doesn’t sound like a lot of funds. But when you can’t manage $10,000, how will you manage funds higher than $10,000?

To properly determine the number of contracts you need to purchase, you should take 2% funding of $200 and then divide it by the price of put/call. When the put/call is doing trading for $20 each, you then have to purchase 10 contracts.

When you have figured out the position sizing, you can stop-set on every trade at a maximum loss of 2%. If it gets hit, then you’re done, and you should get out from there because it’s a bad trade. But when the position begins to provide a profit, you can then think of going up the stop loss and then lock it in the returns.

2.    $100,000 Account Position Sizing

When you have a lot more funds in your pocket, you will begin to see all things changing. But this is the time when there are a lot more risks involved, and you have to protect your portfolio. This is true because a trader can lose over $10,000 in the first week of trading.

This event might take place because the trader didn’t have a proper plan. Let’s say you have a $100,000 account, and you wish to risk $1000 or 1% for every trade. A larger account must be risking less per trade until you’re a day-trading expert.

This is something that is also applied to the larger account. You can take the maximum risk for every trade and then split it to purchase the number of contracts that you want. Utilizing the same amount of $100,000, when you put/call in trading for $20, you have to purchase over 50 contracts.

The bigger account that can trade so many contracts will benefit greatly from all the cheaper commissions. They can also properly use the account margin needs. But still, you have to be sure that you’re addressing the risk tolerance level properly.

Position Sizing Strategies

You will come across many position sizing strategies, and it’s impossible to mention all of them under this section. But you will find the most common and the best position sizing tactics here. Let’s check them out.

1.     The Fixed Dollar Amount

This is the most simple type of position sizing tactic. Here, you need to pick a dollar amount that you want to risk and then adjust the number of stocks or contracts accordingly. When you wish to risk $100 on the trade, you have to first calculate the risks on that trade so that you can adhere to the risk level.

2.    Volatility-Based Position Sizing Strategy

The volatility-based one utilizes the measure of volatility to regulate the position size. The market volatility differs greatly with time, and when there is high volatility, there will be much greater swings. You need to take this into understanding when sizing up the trades.

3.    The Kelly Criterion

Developed by John L. Kelly, the Kelly Criterion is used widely by not just traders but also by gamblers to regulate the position size for every trade or bet.

Chandresh Khona

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