Take Advantage of Position Sizing to Limit Losses

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.

The truth is that size matters a lot in any investment decision. You can get a rough estimate of what you can earn if you look at how much you invest. Obviously, you will have more chances of winning big if you choose to purchase more units. This is the exact reasoning that investors follow when they go for the big fish. They know that the greater the risk, the greater the possibility of winning more. It is not appropriate though to simply base your decisions on the chance to earn a lot. Keep in mind that risking a lot also increases the likelihood of losing a lot. To determine what is ideal for you, your risk management system should include indentifying the scope of your investment.

Getting the right guiding figure to enter a trade isn’t as complicated as you would imagine. You simply have to divide your already predefined maximum loss in dollars by your trading stop size. The result is the maximum number of units you should purchase on a single trade.

The maximum loss element is computed by multiplying the maximum loss percentage with your total trading capital. Some recommend that 1% is the safest to go for but 2% often seems to be a more sensible figure to settle for because it is neither too small nor too huge. To arrive at the stop size, simply obtain the
difference between initial stop and entry.

There are cases in which it becomes useful to add more risk management rules. This is especially true if you are particularly intolerant of risks. It is possible for example to get a risk figure that is still unacceptable for you. If you think you cannot take the risk, add a definitive rule that sets the maximum dollar value that you can endure losing. You could for example get the dollar value for 15% of your total float. This defines the exact amount that you can afford to lose. You can reduce the number of units to buy based on this additional risk control rule.

Position sizing may seem like a technical trading step. In reality though, it is just a sensible way of making sure you don’t drown with the weight of your losses. Do not consider trading without paying due attention to this step. Put as much importance on it as you would on identifying your stops and the size of your float.