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What is Position sizing strategies

Steven Zhao

Sep 21, 2022 16:51


Depending on a trader's trading style and level of risk tolerance, different strategies for sizing positions will work best for them. But if there were one guideline that all traders had to follow, it would be to only risk a small portion of their money in each deal. The precise amount then changes depending on your trading strategy's total risk and degree of diversification.

This article will assist you in determining which position sizing approach is the greatest match for you.

Position Sizing: What Is It?

Position sizing, the process of deciding the transaction size, greatly impacts how well your trading or investing portfolio performs. Many traders just starting make the error of taking on huge holdings hoping to make fast and simple gains. Long-term, this kind of conduct more often leads to despair over significant losses than the contrary.

Choosing the Right Position Size

Position size is crucial since it significantly affects how well you trade. Your earnings won't increase at an appreciably faster pace if you choose a position size that is too tiny. On the other hand, if you choose an aggressive position size, you face the danger of losing all of your trading money. As you may have already realized, the latter is more prevalent than the former.

The two instances mentioned above show the two extreme outcomes obtained by position sizing. To get large returns at manageable risk levels, traders and investors must find a balance between the two. By taking on excessive risk via reckless position size, a trader may have a few exceptional years with big profits. But sooner or later, the day will arrive when he or she is fully extinguished. Remember that although the downside is always limited to 100%, the upside is unbounded.

Position sizing is crucial since the potential is almost endless, while the downside is just 100%.

What position sizing strategies can you use to assess risk and guarantee that you participate in the game? There are a few approaches, though:

The Most Effective Position Sizing Methods

Including every position sizing strategy in one article would be hard since there are innumerable more. As a result, the following list of position sizing techniques only includes the top and most popular methods:

Amounts in Fixed Dollars

One of the easiest position size tactics is a Fixed Dollar Amount. Simply decide how much money you're prepared to risk, and then change the number of contracts or stocks you own to reflect that change.

Therefore, to stick to your risk level, if you are ready to risk $100 on a trade, you must first determine your risk on that specific deal. Here's an illustration:

Our stop loss is at the previous low, and we join the market on a breakout. In the picture below, the entry and stop loss are indicated:


We should not risk more than $100, according to our position size approach. Our risk is computed as follows: $181-$173 = $12 since we enter at around $181, and our stop loss is roughly $173.

By dividing the preset dollar amount of stop loss by the risk per share, we can determine how many stocks we may purchase at the above-set stop loss level:

100/12= 8.3

As you may have seen, the amount of stocks we are able to purchase is entirely reliant upon the location of the stop loss, which is sometimes a pretty arbitrary choice. We will provide you with advice on where to put the stop loss later in the post.

The risk with a Fixed Percentage

The fixed dollar amount technique and this position size strategy are similar in that we set a predefined risk for every transaction. Instead, we use a percent-based risk assessment using the fixed percentage risk strategy. As a general guideline, you shouldn't risk more than 2% of your account in a single transaction. Many traders keep their maximum risk to a couple of percent of the account equity.


This figure, however, is flexible and depends on things like diversity, experience, and individual risk tolerance. You may comfortably take on more risk if you have greater diversity across several markets and methods. However, novice traders should take far less risk when their paper trading phase is through.


Utilizing a fixed % position sizing method can automatically adjust your position size to the size of your account. As your account grows or decreases, you would need to reassess the size of the maximum dollar amount risked if it were a set number. Adopting the fixed percent position size method, this is automatically taken care of for you, and compounding will cause your account growth to speed up over time.

A fixed dollar amount position size technique may achieve the same result. Still, it is more laborious since the dollar amount must continually be adjusted to account for changes in the equity balance.


You just add another step to the set dollar amount method to determine how much you could risk on each deal.

If we trade with a $1000 account and suppose that we wish to risk a maximum of 2% of it, our maximum risk per transaction will be $200. The computation continues for the fixed dollar amount position size technique from this point on.


A Position Sizing Strategy Based on Volatility

The position size is decided using a measure of volatility in a volatility-based position sizing method.

Market volatility fluctuates over time, and increased volatility is accompanied by larger swings, which must be considered when placing your trades. Check out the graph below. The market volatility is assessed using ATR (Average True Range).

As you can see, the volatility varies throughout time, and big swings are more likely when trading a contract with higher volatility. Therefore, amid erratic market conditions, you should reduce the position size and vice versa.


Higher volatility levels, however, can imply that the advantage grows greater for certain strategies. Instead, you may wish to enlarge the position in certain circumstances. However, avoiding investing too much of your trading cash in a single deal is crucial.

How to Use Position Sizing for Volatility Adjusted Data

To determine the appropriate position size, volatility may be measured in various methods. To assess the market's volatility, you might contrast the short-term and long-term ranges or utilize the ATR indicator's preset volatility thresholds.

Per-Trade Fixed Risk

The fixed risk per trade position size method involves a little more work. Three distinct variables determine the position size:

Stop loss for the whole amount of the deal.

Risk as a proportion of account equity for each deal

The whole trading account's maximum risk

The whole trade value stop loss

This stop loss is determined as a portion of the stock price. The stop is placed at $90 on the price graph if the stop loss is 10%, and we acquire a share that is trading for $100.


Risk Per Trade in proportion to trading capital

This is the same as the position size technique based on percentages. We can only risk a maximum of 2% of our trading capital in each transaction if we set this value to 2%.

The Trading Account's Maximum Risk All in All

Here, we set limits on how much cash we may invest in transactions at once. We are only permitted to trade 30% of our trading money once we have a 30% maximum risk threshold.

What Advantages Does This Position Sizing Strategy Offer?

The fixed risk per transaction position size technique has advantages in considering risk at portfolio and individual trade levels. There is no upper limit on the total amount that all transactions may risk when using the fixed % risk technique. You are putting 100% of your cash at risk if you are holding 100 transactions at once, each of which has a 2% risk. The fixed risk per transaction strategy eliminates this danger by capping the maximum portfolio risk.


The Kelly Standard

To estimate the position size for each trade or wager, traders and gamblers often utilize the Kelly Criterion, a method created by John L. Kelly.

The equation reads as follows:

The Kelly Formula

Kelly% is the trading capital that will be used in one deal, and

W is the trading strategy's victory rate.

R is the previous Win/Loss ratio.

The Kelly Criterion's assessment of the trading strategy's past backtest success is one of its primary benefits. In this manner, the position size is modified for the specific trading technique you choose.

Application of the Kelly Criterion

Gather information about your previous 50 transactions. This information may be seen in the backtest report if you run a backtest trading strategy. Their broker's website is where discretionary traders may check their most recent deals.

The "W" in the formula above stands for the victory probability, which you should compute.

Find the "R" in the formula above, which stands for the win/loss ratio.

Find your Kelly Percentage by plugging the data into the calculation.

The position size of your subsequent transaction is represented by the percentage you get. Therefore, if your computation yields a result of 0.02, you should place your next transaction using 2% of your trading money.

Declining Average

Use caution while using this position sizing method since it is highly risky. If the market swings against you, averaging down implies that you keep buying contracts or shares. By doing this, you lower your average price and lower the amount that the stock must grow for you to make a profit.

Mean-reverting methods often involve averaging down, which is also the situation in which they make the greatest sense. The likelihood that a market will shortly reverse increases as it gets more oversold. However, one must use caution. Averaging down might result in significant losses in the event of a "black swan" catastrophe and should be utilized with care.

The trading technique shown below enters when the RSI crosses the oversold threshold and averages down as the market continues to decline.

In this instance, we averaged down twice, which allowed us to exit the trade at a profit rather than a loss if we hadn't averaged down.

A maximum drawdown

The maximum drawdown position size approach is often utilized when building portfolios with various trading methods. Your search for uncorrelated strategies that optimize the drawdown-to-profit ratio by combining various systems and seeing how they perform together.

However, you may combine certain tactics with the greatest drawdown strategy. If you trade with $100,000 in capital and set your maximum drawdown to 30% of that amount, your maximum drawdown will be $30,000.

Now, if your strategy has historically seen a maximum downside of $15,000, you may trade two contracts or twice as many shares.

Important! Remember that estimating the position size based on the previous drawdown is not a secure method. For a figure to be utilized for real trading decision-making, you often need to at least twice the previous drawdown.



Monte Carlo is a simulation technique that operates by randomly rearranging all of the deals in a backtest. By running Monte Carlo up to tens of thousands of times, you may get a statistical estimate of the chance that a future downturn would reach a certain dollar amount.

Therefore, Monte Carlo testing is an extension of the Maximum Drawdown position sizing technique, which considers the likelihood that future drawdowns would be greater than past drawdowns.

How to Place the Stop Loss and Know Where It Is

It is crucial to understand where stop losses should be put since, in many position sizing procedures, they are what decide the position size. Here are a few alternative methods for setting stop losses.

Regarding Levels of Support and Resistance

Zones where the market is likely to revert include resistance and support levels. Whether going long or short, putting the stop loss beneath or above a support or resistance level is a frequent strategy.

We advise reading our in-depth post, which is about 4000 words long to better understand how to employ support and resistance.

Volatility-Based Stop Loss Adjustment

The market's degree of volatility must be considered even if you do not adopt a volatility-based position size technique. You will be stopped out of your trade before the market has even had a chance to move in the direction of your trade if you place your stop losses too near to the entry.

Either backtesting the trading method or observing the ATR indicator may be used to identify the ideal stop loss distance for a market. Usually, a stop loss that is set at around three times the entry's ATR value is effective.

Watch out for contract sizes.

Position size and risk estimation are not difficult when trading equities. You can easily determine the position size since you know the stock's trading price. It is not as simple as other assets, such as futures.

You must be conscious that you are using leverage while trading futures. Although you must adhere to a margin rate, which means you must have a certain amount of money in your account, the real size of the contract and the associated risks are considerably higher. The margin cannot be used to calculate risk since it only represents a small portion of the overall value of a futures contract.

Instead, you should consider the contract's point total. When a point is worth $20, it signifies that moving one point costs $20. Therefore, if your entry point was 1920.00 and your stop loss was 1910, you are taking a $200 risk.



The greatest way to guarantee that we can safeguard our trading money is to adopt position size tactics, even if, as traders, we all want to score that huge winning move. 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 the often repeated adage in the market, "Don't put all your eggs in one basket"? It's not just about diversity, however, and that sage adage's primary concept is risk management or position size.

Additionally, if you can't go asleep at night worrying about your open position, you are taking on too much risk, according to a successful professional trader.