Position sizing is simply the number of contracts that you choose to enter for any specific trade.
It is this, combined with the movement in price (either positively or negatively) from entry to exit in your trade, that determines your final dollar result for any specific trade.
As this result impacts on your trading capital, position sizing, along with appropriate exit decisions and actions, are THE two key factors in both risk management and taking profit.
It is good trading practice to have a “tolerable risk level”, i.e. what you are prepared to lose on a single trade. This, as we have covered in First Steps, is usually expressed as a percentage of your total trading capital (somewhere between 1-4% are commonly used).
For example, If your chosen risk level is 3% and the capital in your account is $5000, this means that you would be prepared to risk $150 on one trade.
Why use formal position sizing?
A formal position sizing system aims to answer the question “how many lots do I enter to keep any loss within my tolerable risk level if my stop loss is triggered?”.
As we enter a trade, we ALL position size, but we have a choice as to how we action this. We can:
2. Use a dollar level i.e. when it hits this we are out (you can retrospectively modify a stop level on a trade chart on your trading platform).
3. Use a technical level as a stop loss and work out how many contracts we can enter based on the Pip movement between entry and stop.
Logically, “3” would seem the most robust AND this should be calculated BEFORE entering a trade.
So how do I position size?
Accepting that the third of the options above is theoretically the optimum method, the process is:
a. What is my “tolerable risk level” in dollar terms?
b. What is the desired technical entry and stop loss price levels?
c. What is the dollar difference between entry and stop loss exit?
d. Divide ”a” (your tolerable risk level) by “c” to get an estimated position size.
If your account is in Australian dollars the calculation is easier than trading either many index CFDs (except for the ASX200) or Forex as there is no need to add a further calculation to convert a profit/loss back into your account currency.
Other position sizing issues to consider:
• Position sizing can only make a difference to your risk management if you adhere to your pre-planned exit strategy.
• Be aware of gapping on market open from previous close price. This is at its potentially most severe subsequent to a company’s earnings report release and so you may want to consider avoiding this situation as part of your risk management plan.
• Once you have mastered basic position sizing, consider whether different market conditions or situations would merit a different tolerable risk level on which to base your position sizing calculations. e.g. a major economic news release increased general market volatility. In such situations it may be that you enter a smaller position initially and then accumulate into the position if it goes in your desired direction.
There is a FREE DOWNLOAD of an excel-based “indicative CFD position size calculator” you are welcome to use to assist you in this important part of trading entry. Feel free to use, but please pay attention to the notes. Click on the link below.
Please feel free to connect with the team with any questions you have about share CFDs and how you can add this to your trading.
Disclaimer: Articles and videos from GO Markets analysts are based on their independent analysis. Views expressed are of their own and of a ‘general’ nature. Advice (if any) are not based on the reader’s personal objectives, financial situation or needs. Readers should, therefore, consider how appropriate the advice (if any) is to their objectives, financial situation and needs, before acting on the advice.