Top 4 Position Sizing Techniques to Boost Your Trading Experience
Education - | 05 Apr 2019
There is no doubt that all traders want to capture big winning trades – those that double, triple or even quadruple your trading capital.
But the fact is trades that deliver 5X, 10X or 20X windfall can be rare.
While they do come along, chances are your trading capital can be wiped out if you put all your money in a single trade thinking that it will be the big one.
Instead of risking all or a big majority of your trading capital in a single trade, you’ll be better of using a rock-solid position sizing strategy.
Most successful traders – whether they are FX traders, index traders, share traders or commodities traders – swear by the importance of position sizing in their success.
And why not? Without proper position sizing you could be risking a big chunk of your trading capital. Ultimately, the bigger risk you take in every trade the bigger the chances of being wiped out.
While it is true that the opposite can happen – that the trade will deliver that much wanted huge win, most successful traders will tell you it is better to limit your position size rather than increase your risk unnecessarily.
Let’s look at four position sizing techniques you can implement to boost your trading.
1. Fixed dollar value – this can be the simplest way to do your position sizing. This may work particularly well for those who are new to trading or who have quite a limited amount of capital. All that it requires is to allocate a fixed dollar amount to every trade that you take.
For example, if you have a $10,000 trading capital, you may want to allocate $1,000 per trade or 1 micro lot (as per the screenshot below). That means you can make 10 trades instead of putting the whole amount in one trade.
This automatically limits the risk you’re taking per trade. It will also help preserve your capital in case the first few trades you take turn out to be losers.
2. Fixed Percentage Risk per Trade – This is the most commonly referred to position sizing technique used by traders. You risk a small percentage of your overall capital on each trade. It is an anti-martingale strategy, which is the preferred method for financial instruments like Forex.
Depending on the financial instrument you’re trading – e.g. FX, Commodities, Indices – most successful traders would say a 1 - 2 percent per trade risk is a good rule of thumb.
Using the $10,000 trading capital example, you should only be risking $100 – $200 per trade if you use the fixed percentage risk per trade technique.
The great thing about this strategy is it gets you to focus on the percent risk instead of a dollar value. Then, as your capital increases from $10k to $20k, your 1% risk moves from $100 to $200 risk per trade. Likewise, if your capital decreases, you still risk just 1% but it will be a smaller dollar amount. Hence it is an anti-martingale strategy.
Because if you don’t, you will soon find out the big risks you take in every trade can easily eat up your trading capital.
3. Contract size value – many Index and Commodity traders use this technique to limit their risks. This is an effective way of controlling your risk while getting exposure to a fast-moving market.
Most trading providers, including AxiTrader, offer different contract sizes for FX, Indices and Commodities. For example, most trading providers offer standard contracts, mini contracts and micro contracts.
Depending on your trading experience and your trading capital, you may want to trade the smaller size contracts first then you can scale up to the standard contract sizes later on.
4. Leverage – while leverage is one of the main factors that attract traders to the FX, Index and Commodities markets, we all know that leverage can be a double-edged sword. It can magnify winnings as well as losses.
Many trading providers offer leverage from 20:1, 50:1, 100:1 or 200:1. Others offer more.
But the thing to keep in mind when it comes to leverage is you don’t have to use the highest level of leverage. Just because it is on offer doesn’t mean you have to use it.
It is better to use a lower level of leverage to make sure you are limiting your risk exposure.
Remember, leverage can magnify winnings as well as losses. If you leverage too much, you’re increasing the risk of a capital wipe out or margin call in case a trade goes against you.
In conclusion, while as traders we all want to bag that big winning trade, it’s best to use position sizing to ensure we can protect our trading capital. After all, we all want to be able to trade the next day (and that will be impossible if all your capital has been wiped out in a single trade).
And remember that oft-repeated market saying not to put all your eggs in one basket? That is not only about diversification. At the core of that wise saying is risk management – position sizing.
And as one successful professional trader once said: ‘if you can’t sleep at night thinking about your open position, you are risking too much.”
Find out more about position sizing and how you can use it to boost your trading here.
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The information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. Readers should seek their own advice. Reproduction or redistribution of this information is not permitted.
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