The Most Important Aspect Of Money
Management - Position Sizing
By Trading Secrets
When we talk about position sizing, were asking
the question, How much are we going to put into any one trade?
Fortunately, by adopting the two percent rule we talked about earlier,
were using a strategy that decreases the size of our losses during losing
streaks. When experiencing a winning streak, our position sizing will
actually grow. Whats more, by simply changing the amount of capital were
wishing to risk, were going to change the characteristics to our risk
to reward ratio.
Many people believe though, theyre doing an adequate job of position
sizing by simply having a stop loss in place. Sure, this will tell us
when to get out and by setting our maximum loss, well also know how much
capital were risking, however, it doesnt answer the question of how
much or how many units we can buy, hence it is poor position sizing. Again,
since weve already calculated our maximum loss and our stop loss, we
can simply take these values, plug them into a formula and calculate how
many shares we purchase without ever exceeding our maximum loss.
Although very simple, this formula for position sizing Im about to give
you is extremely powerful. The position sizing formula goes like this
the number of shares is equal to our maximum loss divided by our stop
loss size. Youre already familiar with what our maximum loss is, I just
need to define what a stop loss size is. Its the difference between our
entry price and our stop loss value. So, if we go back to our example
earlier where we were talking about entering a stock at one dollar and
setting our stop loss at 90 cents, the stop loss value is the difference
between our entry price and our stock price or ten cents.
Its just a matter of plugging the values into the position sizing formula,
and it will calculate how many shares you should buy so you never risk
more than your maximum loss. Now, for those of you who dont like math,
you dont need to worry because Ive made this as easy as possible for
you. Included in this package, you would have also received a money management
calculator to help you figure out your position sizing. So, now all you
need to do is plug in the values into this calculator and youll have
set excellent money management every time.
Lets now look at how this position sizing formula works in practice.
If our trading float was 20,000 dollars, and we were risking two percent,
our maximum loss would be 400 dollars. If our entry price was one dollar,
our stop loss value was 90 cents, our stop size would be ten cents. Now,
to use the position sizing formula, the number of shares is equal to our
maximum loss divided by our stop size. We calculate that we can purchase
4,000 shares. If this stock reaches our stop loss, and we have to exit
the trade, we know were not going to risk or lose more than two percent
of our float, which is 400 dollars.
This position sizing formula is extremely simple, but also extremely powerful.
Another little finesse point that some of my clients like to include is
to class brokerage as part of the maximum loss. So, how would you go about
doing that? Well, if brokerage were 40 dollars for our return trip, wed
subtract 40 dollars from our maximum loss. So, instead of entering our
maximum loss as 400 dollars into the position sizing formula, wed now
enter 360. Once this is computed out, we can determine how many shares
wed buy, and we know that we are including brokerage as part of our maximum
loss. Theres one small caveat that you need to be aware of when using
this formula to calculate how many shares you are going to buy.
The astute listener may have realized how many shares we can purchase
is determined by our maximum loss and also the size of our stop. So, by
increasing our risk, we can also increase the dollar value of the position
sizing, or by simply shrinking our stop size, that is setting a tighter
stop loss, we can increase the dollar value of the position sizing we
So, to avoid this situation where we open excessively large positions
that might put our trading float at risk, you may also introduce an extra
rule that limits the dollar value of a position sizing to be no more than
a set percentage of your entire trading float.
For example, you might say youll never open a position sizing that has
a dollar value of more than 25 percent of your entire trading float. This
rule would only ever get executed if after calculating the formula that
determines how many shares you buy, you find the dollar value of that
position sizing would be an excessively large position and greater than
25 percent of your trading float. If this was the case, all you would
do is simply scale down the position sizing to make sure it never exceeds
that 25 percent.
Now, the percentage value that you decide to choose will depend on the
type of system youre trading, the size of your float, and also your personal
tolerance for risk. As a guide though, smaller trading floats might use
25 percent, whereas larger trading floats might use as little as 10 percent
or even five percent.
There are no definitive answers and it will depend on your personal
circumstances. This leads on to my next point that your study of money
management shouldnt stop with just listening to this course on position
sizing. You need to take the principles that you learn in this course,
realize that I have simply set up the goal posts for you to shoot
between. You need to test your system to find out which of the variables
best suit you, and remember position sizing is the most significant
part of any system design. It is the central theme of money management.
Be sure to take what youve learned here and apply it in your system.
About To Learn Secrets Most Traders Will Never
Know About Profitable System Trading..."
Inside you’ll learn...
to design a winning system from scratch and exactly what
to do to supercharge your current stock trading system!
one ingredient you literally "Drop" into your
stock trading system that can triple your profit!
to use “secret” money management techniques
to minimize your risk.
tools the professionals use and how you can get huge discounts
(charting software, data, etc).
you'll also get a FREE copy of David Jenyns’ complete
Ultimate Trading Systems Course…
Just enter your name & email - then click the “Click
Here For Free Instant Download!” button. (All information
kept 100% confidential). The download details will be
emailed to you immediately.
take your privacy very seriously. My
personal privacy guarantee to you. I respect your privacy
and will never share your email address with anyone. You can
easily unsubscribe at any time. View our Privacy
Policy - David Jenyns Founder of www.ultimate-trading-systems.com
copyright 2005 Position