You can only expect great things to come from position sizing. This is the step in a trading money management blueprint that involves properly identifying how many units you plan to buy on every single trade. Some novice traders though simply don’t give enough attention to it. This is because they are ruled by the idea that initial stops are the most important points to identify. Most experienced traders however know that this is not the case.
Size identification can accomplish one thing well and that is to protect your trading capital. When you’ve arrived at the figure that you know you can securely trade you are ensuring that your float does not get eroded. Position sizing also offers the opportunity to determine loss and win possibilities.
What many investors don’t realize is that size matters. The amount that you put in is the indicator of how much you might earn or lose. The more units you purchase, the higher your chances of winning. This is why some immediately invest a lot, thinking that the more risks they take, the more rewards they get. Deciding on this factor however based only on the opportunity to profit well is not advisable. Remember that a big investment also magnifies your chances of losing. To arrive at the best option for you, your risk management system should incorporate a scientific way of defining the extent of an investment.
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 stop size. What you get is the recommended number of units that you can buy safely and securely.
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 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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