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Trading 101: What is position sizing and why is it important for traders?

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Position sizing is crucial in volatile markets! I use something which I call the three Vs, Volume Versus Volatility. As we have seen and many have experienced too since early 2020 when COVID impacted our lives and the markets, the markets have become extremely volatile at times.

The market will generally move against us first before it turns.…if it is going to! As the markets increase in volatility there is a greater chance than normal that our stop loss will be triggered. Therefore, to allow the market to go further against us without triggering our stop loss and without increasing our potential loss we must reduce the size of the position we open.

Why is position sizing so important?

Position sizing is extremely important and is based on volatility. If volatility is low, I would increase the size of my position to counter the low volatility and if volatility is high, I reduce my volume, allowing for a wider stop loss, however, keeping the overall loss the same.

As an example, with low volatility I may open the position with 50 and aim for 20 ticks/pips profit to generate 1000 or with high volatility I may open with only 10 and aim for a profit target of 100 to generate the same 1000! If I were running a 2:1 risk reward then if I am looking for a 20 tick/pip profit my stop loss would only be for 10 ticks/pips, whereas my 100 tick/pip profit would allow the market to move up to 50 ticks/pips against me before I would be stopped out. In either case the profit would equal 1000 or the loss 500 (low = 50 x 10 stop loss or high = 10 x 50 stop loss).


How I determine the size of my trade

Once I identify the level where I expect the market to find support or resistance, I calculate my risk-reward as this helps decide the size of the position. I now have my key level, then I decide on my entry level and that will provide my mid-level. Once I have evaluated all of that I know where to place my stop loss and this will provide me with how many ticks/pips I could lose per lot/price and the maximum I could lose and that in turn decides the total position size I should use in the trade. I always calculate the loss first, then I must assess where I believe the market could reach if I am right to take my profit and the potential profit must be at least twice the potential loss for me to consider entering the trade.

I prefer to build my position so I will either break my volume into three and place three orders at different prices (I will know my average price) or I will focus on the market and build the position at the pace and prices I feel are right and my trading software automatically adjusts the average price each time I trade.

Knowing the average is important as it provides me with where I must place my stop loss. In the first instance where the volume of my trade is broken into three, I could use the average or place three separate stop losses and treat each trade as a separate trade. The overall loss will still be the same!

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This article does not constitute investment advice. Make sure you do your own research or consult a professional advisor.

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