Many seasoned traders know that position sizing or determining the size of each trade is a vital part of any trading money management plan. Many beginner traders however make the mistake of not paying adequate attention to this step. They believe that it is enough to simply define the initial stops. This however is a very incomplete way of trying to manage your risks.
Determining the size of every trade is crucial for the protection of your trading float. When you are certain about the number of units that is ideal for you to deal with, you are protecting your capital from getting eroded. Moreover, when you fully delve into proper position sizing, you are also able to identify your win and loss potentials.
When taking position size into consideration, it is crucial to remember that size matters. It is not when you enter a trade that reveals how much you might earn but it is how much you put into a trade. Common sense dictates that the more you invest, the greater the profits that you can expect. This is one reason why eager investors put in so much because they expect to gain more. Risk is a good thing but it is not prudent to make decisions based solely on profit potential. You also have to consider that the greater the risk, the greater the possibility of loss too. To get the right position size, your risk management system should be structured in a logical way.
It’s not so difficult to set the size of a specific trade. You just need to take your maximum loss preference converted to a dollar figure and divide it by the stop size. The result is the number of units that you can safely purchase at a single transaction.
To get your maximum loss figure, choose a percentage value that corresponds to how much you are willing to lose. It is highly recommended that you risk losing no more than 2% of your trading capital. This is large enough to offer you good profits but is small enough to limit your losses.
There may be a need to fine tune this aspect of managing risk levels. You have to carefully consider the level of risk that you can bear. If you can’t bear too much loss, the figure that comes out after you’ve made your computations may still be too big for you. If so, you can add more rules to your risk management plan. A good extra rule would be to set an additional percentage value that is convertible to dollars for your maximum loss. You can say for instance that you are not willing to let go of 10% or more of your trading float.
Some traders can get too technical with position sizing. It’s only really right though that a lot of attention be placed on this risk management step. Put as much thought into this part as you would on identifying stops.
