From all appearances, position sizing is a basic trading money management concept. This is part of a comprehensive trading system and aims to identify the size of each trade entered into. Some beginners don’t pay enough attention to this factor. They tend to think that all they really need is to set initial stops. Focusing on just placing stops however is not a very comprehensive plan at all.
Identifying trade size is vital. This is what can contribute to the protection of your trading capital. When you are sure how many units you can afford to buy, you are securing against trading float erosion. Furthermore, true position sizing puts you in the ideal spot to find out your potential to lose or win.
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.
The computations involved are not as nerve wracking as you would think. What you need to do is to take your maximum loss in currency value and divide it by your trading stop size. What you get is the recommended number of units that you can buy safely and securely.
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.
Position sizing is not rocket science. The fact that it is a basic concept however should not be enough of a reason for you to give it only a passing glance. It is as important as identifying your trading stops so make sure you don’t skip it.
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