How to calculate position size

Many successful traders regard position sizing as the holy grail of risk management, ultimately of trading successfully. Essentially it’s the quantity of the chips you want to bet on a trade, and is related or at least should be related to how much you want to risk on that trade.

 

A trade at least in the beginning has 4 primary components

 

  • Direction
  • Entry
  • Exit (stop loss and Target)
  • Position size

Direction, entry, and exit could be determined either through technical analysis or fundamental analysis. When you enter into a trade for whatever reason, you have to determine the size of your bet/trade. While many methods exist I will share the method that I use to size my bets.



A trade has 5 possible outcome

 

  • Small winner
  • Small loser
  • Big winner
  • Big loser
  • Breakeven

 

Depending on your position sizing you will get one of the above when exiting a trade. How big is big or how small is small, is a subjective call from by the trader. 

 

Your job as a trader is to limit those outcomes to just 4 to exclude the big losers. The big losers not only damages your account balance but your confidence as well. 

 

Before getting into position sizing its important to understand the importance of a stop loss. A predetermined level in which you will exit the trade should the trade not work out. We use this level to calculate our bet size. To calculate your bet size, you have to divide the maximum you willing to lose on a trade by the risk per share.

 

Here how it works

 

Say you’re about to enter into a trade, based on technical or fundamental analysis and you’ve determined your stop loss level as well and your target. For the purposes of this example, I will assume the following and will not factor in slippage and commission

 

Account balance: R10 000

Max risk per trade: 2%

 

Long example 1

Entry: R10

Stop loss: R8

Risk: R10 – R8 = R2 per share

Target: R14 

Potential reward: R14 – R10 = R4

Risk Reward ratio: R4/R2 = 2:1

Maximum risk: R10 000 * 2% = R200

Position size: R200 / R2 = 100 shares

 

Long example 2

 

Entry: R10

Stop loss: R7

Risk: R10 – R7 = R3 per share

Target: R16

Potential reward: R16 – R10 = R6

Risk Reward ratio: R6/R3 = 2:1

Maximum risk: R10 000 * 2% = R200

Position size: R200 / R3 = 66 or round off to 67 shares

 

Now let’s look at short examples

 

Short example 1

 

Entry: R10

Stop loss: R12

Risk: R12 – R10 = R2 per share

Target: R6

Potential reward: R10 – R6 = R4

Risk Reward ratio: R4/R2 = 2:1

Maximum risk: R10 000 * 2% = R200

Position size: R200 / R2 = 100



So it doesn’t matter how wide or tight your stop-loss is, you’ll always risk the same % of your account equity on each trade. This % is also subjective to the trader. This % will to some large extent determine the length of your stay in the markets. The smaller it is the longer your stay will be.

 

The goal of a successful trader is first the long term capital preservation, It keeps them in the game for longer. You can only win a game if you’re in the game. Correct position sizing can ensure your long term survival.

Leave a Comment

Your email address will not be published. Required fields are marked *