Position sizing refers to the calculating quantity of stocks to invest or trade which helps traders/investors to manage the risk. In other words, position sizing is a simple calculation that helps to manage the risk and stress of the trader/investor.
If you don’t define position size properly before entering into trade or investing, your strategy will fail, no matter how accurate it is.
As discussed, position size is the no of stocks you trade. The total risk is divided into two parts – trade risk and account risk. When you understand these two elements with an ideal position size and in any market condition you can trade without any stress as you already know how much risk is involved with the trade.
Now when you trade there are always two possibilities either you get a target or stop-loss.
Now, assume that
1. You made a loss with a small position
2. You made a loss with a huge position
In both cases, you made a loss but when it comes to the second case it will be more painful because of the huge position. If you follow the right position size method you will be profitable.
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Position Size Rule:
Never take more than 2% risk of your capital on one trade. Let’s understand it with an example
If you have 1, 00,000 ₹ trading capital and your risk per trade is 2% that is 2,000₹ per trade. You need continues 25 losing trades to blow your 50% of capital.
Now you know the risk is 2000 ₹ per trade and if you are taking a long position on ABC stock @500₹ and
stop loss is 495₹ i.e. 5₹ per share.
So the number of stocks available to trade = risk per trade/ stop loss = 2000/5 =400 no of shares you can trade according to your stop-loss.
Now if your stop loss is at 490 ₹ i.e. 10 ₹ per share then,
Tradeable quantity = 2000/10 = 200 no of shares you can trade.
So, maintaining the proper position helps you to trade with consistency and this will leads to a stable and growing trading account.
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Importance of Position Sizing
When you start trading with a big position size just trusting your strategy and your assumption that the trade will be in your favor will be always ended up with the losing side.
Position sizing is directly related to preventing excessive losses. It will help you to trade stress-free.
As your risk is pre-identified your mind is already prepared for it so you can focus more on the trading strategy and your trading account.
Position sizing is not only about the number of shares and saving capital but it will also help you to stay consistent in the market so you can get the best performance.
Position sizing is not just a calculation but it also helps to stay out of emotions while trading. As you know risk per trade before you take the trade, you have your entry, exit, stop-loss, and the right number of shares you are mentally prepared for the loss. So in this scenario, you can take a better decision without any stress, and also prevents you from overtrading.
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To achieve your trading goals, you must know the right position size according to the risk you can take. It will help you to become more discipline and you can achieve a consistently positive result without any stress by taking the right decisions.