Last Updated on 7 April, 2022 by Samuelsson
To achieve success in trading, it is important to know the right proper position size for each trade. Using the right position size allows the trader to endure a losing streak without depleting his trading capital. One easy way of getting the position size is using the Excel position size calculator provided on the trading platform. But what is position sizing, and how is it calculated?
Position size refers to the number of units of an asset you buy or sell in a single trade. It shows how many shares you take on a stock trade or how many contracts you take on a futures trade or how many lots you trade in the forex market. You don’t just choose any number of units to trade based on your conviction about a trade; you calculate your position size using your risk and money management parameters.
In this post, we’ll discuss the following:
- What position sizing and position size are
- How to determine position size
- Position sizing example
- How to calculate the position size on a calculator
- Quick position sizing estimation tips
- How do you calculate crypto position size
- Portfolio position sizing
What is position sizing?
Position sizing refers to the process of choosing the right number of units of an asset you want to trade. The number of units of an asset you buy or sell in a single trade is known as your position size. In other words, it shows how many shares you take on a stock trade, how many contracts you take on a futures trade, or how many lots you trade in the forex market.
Traders don’t choose their position sizes arbitrarily or based on how convinced they are about a trade; they use a simple mathematical formula that factors in their stop loss size, the unit size of the asset they trade, and how much of their trading capital they wish to risk per trade. The essence of calculating the appropriate position size is to control risk, maximize returns on the risk, and make room for any losing streak.
Obviously, the appropriate position size for you will depend on your account size and risk tolerance. Most experienced traders recommend risking no more than 1% to 2% of total trading capital on any one trade to reduce the risk of ruin in trading. That is, a futures trader with a $10,000 account should use a position size that allows him to risk only $100 (1%) or, at most, $200 (2%) in a trade.
Note that in stocks, position size is measured in the number of shares; in futures, it is measured in the number of contracts; while in forex, it is measured in lots.
How do you determine position size?
To determine the position size, three key factors must be known. They are as follows:
The account risk
The trade risk per unit
The unit value
The formula for calculating the position size is given as:
Position size = account risk ($)/trade risk
= account risk ($)/(stoploss x unit value)
For stocks, the formula is:
Position size (number of shares) = account risk ($)/(stoploss (%) x share price)
For futures, the formula is:
Position size (contracts) = account risk ($)/(stoploss in ticks x tick value)
For Forex, the formula is:
Position size (lots) = account risk ($)/(stop loss in pips x pip value)
Now, let’s look at the steps to take when calculating position size manually.
1. Determine your account risk
The first thing to consider when trying to find your position size is your account risk. This refers to the percentage of your account you’re willing to risk in each trade. If you’re a beginner, it’s recommended you risk only 1%, or less, of your account in each trade. So, if your capital is $1,000, for example, you risk only $10 ([1/100]x1000) per trade, and if it is $50,000, you risk $500 ([1/100]x50,000) per trade.
By risking only 1% of your capital in a trade, you can afford to make up to 100 trades even if you keep making losing trades. If you risk 5% of capital per trade, you only have 20 chances to trade. In this case, if you have a losing streak, say 20 losses, you are out of the game, while someone who maintains a 1% account risk would still have 80% of his capital to continue playing.
2. Determine your trade risk
The next thing after the account risk is to determine your trade risk, which is basically the dollar value of your stop loss. If you’re trading stocks, your trade risk can be estimated by subtracting the price level at which you placed your stop loss from the entry price.
For example, if you placed a trade to buy a stock that is trading at $50 per share and put your stop loss just below a suppot level at $48, your trade risk would be $50 – $48 = $2. But if your stop loss is a percentage of the stock price, say 5% stop loss, you have to multiple by the stock price to get the trade risk. For example, 5% of $50 means (5/100) x $50 = $2.5
In the futures market, the stop loss is measured in ticks, so to find the trade risk, you multiple the stop loss by the value of each tick. Different futures contracts have their own tick values. In Forex, stop loss is measured in pips, and different currency pairs and lot sizes have their own pip values — to get the trade risk, you multiple the stop loss by the pip value.
Generally, traders study the price chart to find support and resistance levels they can use as a guide for where to place their stop loss. Some also use volatility measures as a guide. For example, some use multiples of the ATR as their stop loss. Whichever way the stop loss is estimated, its dollar value is your trade risk, which is used in calculating position size.
3. Calculate position size
When you have gotten your account risk and trade risk, you simply get your position size by dividing the account risk by the trade risk.
Position size = account risk ($)/trade risk
Position sizing example
Let’s say that you have a $10,000 account and want to buy XYZ stock at $20 per share. You have a rule to risk only 1% of your capital in a trade. Meanwhile, ATR shows that on average, the stock fluctuates (volatility) by about $1 each day. Looking at the chart, you can see a strong support level at $18.25. As a smart trader, you plan to use 2 ATR ($2) for your stop loss, and this places your stop loss order at $18.00 ($20 – $2), which is a bit below the support levels at $18.25.
From the above, your account risk is (1/100) x $10,000 = $100
Your trade risk is $2
So, your position size (number of shares) will be $100/$2 = 50
Since the stock is trading at $20 per share, the dollar value of your position will be 50 x $20 = $1,000. So, your account balance of $10,000 can take care of the trade — you aren’t using leverage. In fact, the trade is worth only 10% of your account balance. Meanwhile, your trade risk of $2 implies a stop loss of 10% (2/20). In effect, you are risking 10% of 10% (the position’s worth) of your account balance, which gives a 1% risk on you’re your balance.
How do you do position size on a calculator?
Instead of going through all these calculations, many brokers have an Excel position size calculator on their trading platforms. Even when they are not embedded on the trading platform, there are many Excel-type position size calculators you can download online.
With a position size calculator, all you need is to fill in the spaces for the various parameters, such as these:
- Account size
- Percentage of account to risk or dollar amount to risk
- Stop loss size
- The unit value of the asset you are trading
Quick position sizing estimation tips
From what we discussed above under the example, you can see that there is a correlation between the stop loss percent and the dollar worth of your position as a percentage of your account balance. So, you can use these tips for quick estimation of your position size:
- When you are risking only 1% of your account capital: If you plan to use a 5% stop loss, your position’s worth will be 20% of your account capital — dividing this value with the share price can give you the number of shares to trade. For a 10% stop loss, the position’s worth would be 10% of your account capital. A 20% stop loss means that the position’s worth would be 5% of your account capital.
- When you are risking 2% of your account capital: If you plan to use a 5% stop loss, your position’s worth will be 40% of your account capital — dividing this value with the share price can give you the number of shares to trade. For a 10% stop loss, the position’s worth would be 20% of your account capital. A 20% stop loss means that the position’s worth would be 10% of your account capital.
How do you calculate crypto position size?
Calculating position size in crypto is the same as in other assets. Position size in cryptos is calculated as follows:
|Position size = Account size X percentage risk per trade X Stop Loss size|
Account size = your equity balance
Percentage risk per trade = the amount you are willing to risk on the trade
Stop loss = current price – invalidation point