What is position sizing?
Position sizing is the process of choosing the number of units, shares, contracts, or lots to trade. It prevents traders from using the same trade size in every market condition.
A wider stop-loss generally requires a smaller position size if the trader wants to keep the same monetary risk.
Risk percentage
Many traders choose to risk only a small percentage of their account on an individual trade. The appropriate percentage depends on the trader's experience, strategy, account size, and personal risk tolerance.
For educational purposes, a trader might choose a 1% maximum risk rule. This is an example, not a universal requirement or guarantee.
Basic position-size calculation
A simplified position-sizing formula is:
Position size = Maximum monetary risk ÷ Risk per unit.
For example, if a trader accepts a maximum loss of $50 and each unit would lose $2 when the stop-loss is reached, the position size would be 25 units.
Factors that affect position size
Position sizing must account for the instrument's contract specifications, pip value, tick value, currency conversion, spread, commissions, and possible slippage.
- Account balance.
- Risk percentage.
- Stop-loss distance.
- Pip or tick value.
- Contract size.
- Trading costs.
- Market volatility.