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Trade Articles

Trade Articles

Trade Articles

Disclaimer: The views on the posts and charts are for educational and illustration purpose only, as past performance is not necessarily indicative of future performance. They are provided for general information only and therefore should not be taken as any offer or solicitation to do any investment or trade.

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Position Sizing For Risk Control

By Hector in Trade Articles on 05 June 2019

What is Position Sizing?

Position sizing determines how many shares or contracts you are going to take in a trade with reference to the size of your account. You may have the best trading system. However, if you position sizing is wrong, you are likely to continue paying your lessons fee in your trading journey! Let me explain…

 

Position Sizing

 

Why Position Sizing is Important?

 

Have you ever had your trading account blown up because of over trading in your positions. You might have started with $10K, $50K or $100K in your account but ended up with near zero after trading for a while. Most traders would have gone through that at least once (paying lesson fees) because of poor risk control. For me, during my early days of trading, it was once bitten still not shy! So I was bombed out twice before I learned about Position Sizing to control my risk.

 

Drawdowns 

 

Below is a table that shows how much your trading account has to recover from increasing drawdowns in order to return to break even . When your account has a 50% drawdown, it will require a 100% gain just to get back to even. Beyond 50%, it would be even harder to recover all your losses. Subsequently, as you take more risk with the intention to recover but lose further, your account would already have blew up. Sound familiar?

 

Recovery After Drawdown

Loss, % Gain to Recovery, %
5 5.3
10 11.1
20 25
30 42.9
40 66.7
50 100
60 150
70 233

 

How to calculate Position Sizing

 

Firstly, to help you understand what is Position sizing, I will explain the terms used to calculate it.

For example, you open an account with a broker and deposit fund in it. It can be $10K, $25K, $50k , $100K or more. Regardless of how small or big your account is , the position sizing technique can be applied the same to all.

 

Percentage Risk in Position Sizing

 

Let say you open an account with $100,000 deposited . For each trade, you’ll decide in percentage the maximum fixed risk to your capital you’ll lose in the trade. For example, if the maximum risk per trade is 1%, then your maximum risk capital ( C ) is $1000 (1% of $100,000).

Before entering a position ,it is important to know at which point that your trade is wrong. At that point, you must cut your loss and get out of the position. This is your risk per share (R).

If you are bullish and long (buy) a stock @ $10 with the intention to cut loss @ $9.50, then your risk per share (R) is $0.50.

Conversely, if you are bearish and short (sell) a stock @ $8 with the intention to cut loss @ $8.30, then your risk per share (R) is $0.30.

 

Example

 

Using the same account with $100,000 portfolio equity fund, you set the maximum risk cash ( C) at 1% or $1,000 . You get a price action signal to buy a stock  at $5.00 with a cut loss point at $4.80. Your risk per shares (R ) = $0.20.

To calculate how much to trade with  Position Sizing (P), we perform the C P R method:

Position Size (P )     =            Cash ( C )
                                                 Risk  ( R )

                                 =               $1000
                                                   $0.20
     

                                 =              5,000   shares

Henceforth, you will buy only 5000 shares with position sizing for the stock at $5.00 and  your total trading capital used is $25,000. However, your risk per share is $0.20 and the maximum risk for the trade is $1000 or 1% of your account.

 

Risk Control With Position Sizing

 

Following the use of position sizing in your trading, below are the risk control measures you would have taken:

  1. Avoid Over Trading 

    With position sizing, it will limit the number  of trades that your account size allows. Using $100,000 in the account with each position invested at $20,000 to $25,000 at 1% risk, the number of trading positions will be in the range of 4 – 5 at any one time.

  2. Quality is better than quantity. 

    With only 4 – 5 positions at any one time allowed, it will require a trader to be disciplined and takes only the best trade setups. For instance, if you get many signals to enter, you will need to shortlist and choose the best setups to trade. Such setup will have many conditions ticked in the charts to add up for a high probability win trade.

  3. Flexibility

    Some traders may prefer to have more positions of up to 10 trades. You can do so by reducing the risk to 0.5% of the account and limiting the trading capital to $10,000 for each trade. Subsequently, the Position Sizing is reduced.

  4. Adaptive Risk Adjustment With Performance

    If you are doing well and as a result, your account size has increased to $120,000. Using the same 1% risk, your maximum risk for a trade is now increased to $1,200 and Position Sizing increased to 6000 shares  ($1,200 / $0.20).

    On the other hand, you may be a new trader that just started the trading game and not doing well initially. Subsequently, your account is reduced to $80,000. With the CPR formula, it will require you to risk a lower amount of capital to $800 and reduce Position Sizing to 4000 shares ($800 / $0.20). After you have done well and your account recovers to $100,000, your Position Sizing may revert back to 5000 shares.

 

No More Game Over

 

In conclusion, it is very important for traders to preserve their trading capital to play the trading game. To prevent your trading account from being blown up, you need to have some risk control measures to protect yourself from over trading. Hence, I encourage you to use Position Sizing before initiating a trade for better trade management.

If you lose all your chips, you are out of the game!

In our free online course to our members, we teach you how to incorporate position sizing technique into price action trading.

You may consider opening an account with Phillip Securities for swing trading. The most suitable account type for position sizing is the Custodian Account.  It allows you to deposit funds in the account and calculate all your shares values, Singapore and foreign shares included. Consequently, it will be easier to see how your portfolio is performing and adjust your position sizing accordingly.

 

Happy Trading!
One Good Trade

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