Position sizing 101 - how to avoid crippling losses
Position sizing is determining the correct size of the position based on the amount of money you risk on the particular trade.
Before you can do that, you need to figure out what is the maximum acceptable risk of the trade.
That risk is usually expressed as a % of your balance, that you are willing to lose.
To make sure you don’t lose more than this amount traders set a Stop Loss order which is the real maximum exposure of your position.
If you don’t use a stop loss, you are exposing your entire portfolio!
Where to put a stop loss?
Rule of thumb:
Have a clear approach to risk:
1. Set a risk limit for each trade, asset in general, day, week, and month (you won’t risk more than X account)
2. Determine the right position size and start small
3. Increase the position size of trades slowly if your account grows
4. Lower size or switch back to paper trading if your account doesn’t
Two types of position sizing methods: Fixed and flexible
Fixed position size
Flexible position size
How to calculate the correct position size:
You need to know
1. Trading account size
2. Acceptable risk (in % per each trade)
3. Invalidation point (in form of a distance from the open price)
The formulae:
Position size = Trading account size x Acceptable risk / Invalidation
Example:
1. Trading account size = $10,000
2. Acceptable risk = 1%
3. Invalidation point = 4% drop in market price
Position size = $10,000 * 0,01 / 0,04 = $2,500
This way you will always risk losing $100 no matter where your Stop Loss goes! If Stop Loss must be wider, say 8%, the calculation is:
Position size = $10,000 * 0,01 / 0,08 = $1,250
Doubling the distance to our stop loss has us reducing our position size by half to maintain the same possible loss.
How to set position size in Tradingview
1. Use the Long position or Short position drawing tool
2. Input your account balance
3. Select the risk you're willing to undertake - either as a % of your account balance or as a monetary value
4. Enter the market price of your Stop Loss
5. Look at the "Quantity" field in the drawing tool = that is the position size you should use to adhere to your risk settings.
Before you can do that, you need to figure out what is the maximum acceptable risk of the trade.
That risk is usually expressed as a % of your balance, that you are willing to lose.
To make sure you don’t lose more than this amount traders set a Stop Loss order which is the real maximum exposure of your position.
If you don’t use a stop loss, you are exposing your entire portfolio!
Where to put a stop loss?
- That’s where Technical Analysis can be handy. The majority of retail traders would look at the chart to find out – usually behind some support/resistance level or based on some volatility indicator, such as ATR
Rule of thumb:
- Risk between 1-3% of your portfolio balance on each position. This way any single individual loss won’t wipe your account and break your spirit. And more importantly, even a string of losses will leave you with enough ammunition to recoup the losses.
Have a clear approach to risk:
1. Set a risk limit for each trade, asset in general, day, week, and month (you won’t risk more than X account)
2. Determine the right position size and start small
3. Increase the position size of trades slowly if your account grows
4. Lower size or switch back to paper trading if your account doesn’t
Two types of position sizing methods: Fixed and flexible
Fixed position size
- Using the same position size for every trade
- Good for finding out if your strategy has an edge
- Make sure you come back and reevaluate position size periodically.
Flexible position size
- Using a percentage of the current balance
- Cluster of wins makes every following win larger
- Cluster of losses makes every following loss smaller
How to calculate the correct position size:
You need to know
1. Trading account size
2. Acceptable risk (in % per each trade)
3. Invalidation point (in form of a distance from the open price)
The formulae:
Position size = Trading account size x Acceptable risk / Invalidation
Example:
1. Trading account size = $10,000
2. Acceptable risk = 1%
3. Invalidation point = 4% drop in market price
Position size = $10,000 * 0,01 / 0,04 = $2,500
This way you will always risk losing $100 no matter where your Stop Loss goes! If Stop Loss must be wider, say 8%, the calculation is:
Position size = $10,000 * 0,01 / 0,08 = $1,250
Doubling the distance to our stop loss has us reducing our position size by half to maintain the same possible loss.
How to set position size in Tradingview
1. Use the Long position or Short position drawing tool
2. Input your account balance
3. Select the risk you're willing to undertake - either as a % of your account balance or as a monetary value
4. Enter the market price of your Stop Loss
5. Look at the "Quantity" field in the drawing tool = that is the position size you should use to adhere to your risk settings.
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