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How Proper Position Sizing Can Mean More Profits
Money management is the key to successfully operating a binary options trading account. You can never allow your self to risk so much on any one trade that it could wipe you out. Trading $100, $50 or even $25 at a time may not seem like much but if you opened your account with the minimum deposit that $100 could equal half of your account. With odds like that you would only have to lose twice in order to wash your account right out of the market. I’m sure when you think about it like that you can understand why trading $25 may not be such a small trade after all. Most successful traders will only risk very small amounts on each trade in order to protect themselves from catastrophic losses. For best results I suggest setting a percentage you are willing to lose. 1-3% is the usual.
Why a percentage? That is because if you use a percentage the size of each trade will grow as the size of your account grows. An account of $5,000 using 1% as a benchmark trade size would be able to trade $50 increments with each position. When the account grows to $6,000 the trades can grow to $60, ensuring you maximize your profitability at the same time you are protecting your balance. It just makes sense to do it this way. If you were to pick an arbitrary number then you may be exposing yourself to too much risk or you could be cheating yourself out of potential profits.
Position Sizing And The Option Builder
There is another step to the 1% money management technique and that is position sizing. This the process of applying the 1% rule to your account and trades. Let’s say for example that the account is worth $10,000 and risk amount is 1%. This does not mean each trade will be $100, it means that each trade can lose $100. If your broker does not offer a rebate and each trade loses 100% then each trade will be $100. If your broker has rebates or if you are using the Option Builder or some other similar tool then your trades will be different. For example, if your trade returns 15% on a loser then each trade will be $117.65 ($117.65 – 15% = $100). This is one reason why choosing a broker with a rebate is better than one without, you have the chance for greater profits. The Option Builder is a tool perfect for binary traders concerned with position sizing and risk management. The tool allows you to fine tune risk/reward profiles to fit your needs and maximize profits.
Money Management Means More Trading And More Profits
There are several reasons why this true. First the obvious, if you make large trades then you can only make a few trades at a time. A trade that is 25% of your account means only four trades at one time and if one loses you are down 25%, 2 losses means 50%. Trades that are 10% of account value means ten trades at one time and trades that are only 1% of your account mean you can have up to 100 trades open at any one time.
Money management also means you can keep on trading, even if you have a losing streak, because no one trade will damage you. Even less obvious is the fact you can trade whenever you see a signal, no more waiting around for funds to become available. If you are trading positions that are too large and have your account tied up you will not be able to take every signal you see. You will have to wait for a trade to close, profitably I might add, before any new trades can be made.
Risking less and trading more makes it easier to break even and be profitable. Let’s assume you are using my 1% Rule and have an account of $10,000. This means that each loser is only going to impact your profitability by 1%. Assuming you trade 5 times per week with an 85% return and no rebate will require a win percentage of 60% to be profitable. This results in a gain of $55 or 0.55%. Trading at ten times per week required a percentage of 60% also and returns $110 or just over 1% of account value. Trading 20 times per week requires only a 55% ratio which returns $35 but if we assume the 60% rate required for the first two scenarios then profits jump to $220 or 1.1%. Now for the finale, assuming the account is worth $10,000 and you are fully invested using the 1% rule you only have to win 54% of the time to break even. If you assume the 60% win rate that is required to break even when making fewer trades then the returns jump to $1100 or 11% of original account balance.
How to Reduce Risk With Optimal Position Size
Determining how much of a currency, stock, or commodity to accumulate on a trade is an often-overlooked aspect of trading. Traders frequently take a random position size. They may take more if they feel “really sure” about a trade, or they may take less if they feel a little leery. These are not valid ways to determine position size. A trader should also not take a set position size for all circumstances, regardless of how the trade sets up, and this style of trading will likely lead to underperformance over the long run. Let’s look at how position size should actually be determined.
What Affects Position Size
The first thing we need to know before we can actually determine our position size is the stop level for the trade. Stops should not be set at random levels. A stop needs to be placed at a logical level, where it will tell the trader they were wrong about the direction of the trade. We do not want to place a stop where it could easily be triggered by normal movements in the market.
Once we have a stop level, we now know the risk. For example, if we know our stop is 50 pips from our entry price for a forex trade (or assume 50 cents in a stock or commodity trade), we can now start to determine our position size. The next thing we need to look at is the size of our account. If you have a small account, you should risk a maximum of 1% to 3% of your account on a trade.
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Assume a trader has a $5,000 trading account. If the trader risks 1% of that account on a trade, this means he or she can lose $50 on a trade, which means the trader can take one mini-lot. If the trader’s stop level is hit, then the trader will have lost 50 pips on one mini lot, or $50. If the trader uses a 3% risk level, then he or she can lose $150 (which is 3% of the account). This means that, with a 50-pip stop level, he or she can take three mini-lots. If the trader is stopped out, he or she will have lost 50 pips on three mini lots, or $150.
In the stock market, risking 1% of your account on the trade would mean that a trader could take 100 shares with a stop level of 50 cents. If the stop is hit, this would mean $50, or 1% of the total account, was lost on the trade. In this case, the risk for the trade has been contained to a small percentage of the account, and the position size has been optimized for that risk.
Alternative Position-Sizing Techniques
For larger accounts, there are some alternative methods that can be used to determine position size. A person trading a $500,000 or $1 million account may not always wish to risk $5,000 or more (1% of $500,000) on each and every trade. They may have many positions in the market, they may not actually employ all of their capital, or there may be liquidity concerns with large positions. In this case, a fixed-dollar stop can also be used.
Let’s assume a trader with an account of this size wants to risk only $1,000 on a trade. He or she can still use the method mentioned above. If the distance to the stop from the entry price is 50 pips, the trader can take 20 mini-lots, or 2 standard lots.
In the stock market, the trader could take 2,000 shares with the stop being 50 cents away from the entry price. If the stop is hit, the trader will have lost only the $1,000 that he or she was willing to risk before placing the trade.
Daily Stop Levels
Another option for active or full-time day traders is to use a daily stop level. A daily stop allows traders who need to make split-second judgments and require flexibility in their position-sizing decisions. A daily stop means the trader sets a maximum amount of money he or she can lose in a day, week, or month. If traders lose this predetermined amount of capital or more, they will immediately exit all positions and cease trading for the rest of the day, week, or month. A trader using this method must have a track record of positive performance.
For experienced traders, a daily stop loss can be roughly equal to their average daily profitability. For instance, if, on average, a trader makes $1,000 a day, then he or she should set a daily stop-loss that is close to this number. This means that a losing day will not wipe out profits from more than one average trading day. This method can also be adapted to reflect several days, a week or a month of trading results.
For traders who have a have a history of profitable trading, or who are extremely active in trading throughout the day, the daily stop level allows them freedom to make decisions about position size on the fly throughout the day and yet still control their overall risk. Most traders using a daily stop will still limit risk to a very small percentage of their account on each trade by monitoring positions sizes and the exposure to risk a position is creating.
A novice trader with little trading history may also adapt a method of the daily stop-loss in conjunction with using proper position sizing—determined by the risk of the trade and his or her overall account balance.
The Bottom Line
To achieve the correct position size, we must first know our stop level and the percentage or dollar amount of our account that we are willing to risk on the trade. Once we have determined these, we can calculate our ideal position size.
How to Determine Proper Position Size When Trading – Any Trade, Any Market
A crucial element of trading success is taking the proper position size on each trade. Position size is how many shares you take on a stock trade, how many contracts you take on a futures trade, or how many lots you trade in the forex market. Position size is not randomly chosen, nor based on how convinced you are a trade will work out. Rather, position size is determined by a simple mathematical formula which helps control risk and maximize returns on the risk taken.
There are three steps to determining the proper position size, and it works for any market. We will then look at couple alternative position sizing techniques for specific circustances.
Position Sizing Strategy Step 1 – Determine Account Risk
No matter if your account is large or small—$1000 or $500,000–a single trade shouldn’t put more than 1% of your trading capital at risk. On a $1000 account, don’t risk more than $10 on a trade, which means you’ll need to trade a micro forex account. If your account is $500,000, you can risk up to $5,000 per trade.
While it’s not recommended, if you risk up to 2% of your account per trade, then on a $25,000 account you can risk $500 per trade. On a $50,000 you can risk $1000, and so on.
Why only 1% risk? Even great traders can experience a string of losses. But if you keep risk below 1% per trade, even if you lose 10 trades in a row (should be very rare!) you still have almost all your capital. If you had risked 10% of your account on each trade, and lost 10 in a row, you’d be a wiped out. Also, even with risking 1% (or less) on each trade you can still make great returns.
Only risking 1% also helps avoid the disaster scenario where you end losing much more than anticipated. A stop loss order doesn’t guarantee an exit at the price we specify. In a volatile move, or an overnight gap in price, we could lose substantially more than 1% (called slippage). If we only risk 1%, usually those devastating moves only result in a several percentage drop in equity which is easy to recover. Had you risked 10% on the trade though, such a move could wipe up half or nearly all your capital.
If your account is larger, you may wish to risk less than 1%. In that case, choose a fixed dollar amount that is less than 1% and use that as your account risk. A $1 million dollar account can risk $10,000 per trade, but you may not want to risk that much (not to mention, liquidity becomes an issue with bigger position sizes). Instead, you may opt to only risk $1,000, for example. $1,000 is less than 1% so it’s a suitable figure, and is the account risk ($) which you’d use in step three.
What is 1% of your account, in dollars? That’s your account risk, and it’s how much you can risk on one trade.
Position Sizing Strategy Step 2 – Determine Trade Risk
To determine our positions size we must set a stop loss level. A stop loss is an order that closes out the trade if the price moves against us and reaches a specific price. This order is placed at a logical spot which is out of range of normal market movements, and if hit, let’s us know we’re wrong about the direction of the market (at least for the moment).
Figure 1 shows a trade example in the EURUSD. The price climbs into a former resistance area, but then stalls out, moving sideways then dropping. This triggers a short trade (a method covered in the Forex Strategies Guide eBook). The entry price of the short is 1.14665 and we place a stop loss at 1.15045. This results in a trade risk of 38 pips.
Figure 1. EURUSD with Entry, Stop loss and Trade Risk
You’ll need the trade risk in order to move onto the next step in determining proper position size. For forex, we measure trade risk in pips, in the stock market in cents or dollars, and in the futures market we measure it in ticks or points.
Assume you buy a stock at $9.50, and place a stop loss at $9.40. The trade risk is $0.10.
If trading a futures contract, how many ticks or points are there between the entry and exit price? If trading the E-mini S&P 500 (ES), and you buy at 1220 and place a stop loss at 1210, that’s a 10 point (or 40 tick) trade risk.
Position Sizing Strategy Step 3 – Determine Proper Position Size
You now have all the information you need to calculate the proper positions size for any trade. You know your account risk, and you know your trade risk. Since trade risk will fluctuate on each trade, and your account risk will also fluctuate over time as your balance changes, your position sizes will be different from one trade to the next, usually.
To calculate position size, use the following formula for the respective market:
Stocks: Account Risk ($) / Trade Risk ($) = Position size in shares
Assume you have a $100,000 account, which means you can risk $1000 per trade (1%). You buy a stock at $100 and a place a stop loss at $98, making your trade risk $2.
Stocks: $1000 / $2 = 500 shares.
500 shares is your ideal position size for this trade, because based on your entry and stop loss you are risking exactly 1% of your account. The trade costs you 500 shares x $100 = $50,000. You have enough money in the account to make this trade, so leverage is not required.
Forex: Account Risk ($) / (Trade Risk in pips x Pip Value) = Position size in lots
Assume you have a $5,000 account, which means you can risk $50 per trade. You buy the EURUSD at 1.1500 and place a stop loss at 1.1420, making your trade risk 80 pips. To complete the formula you’ll need to know the pip value of all pairs you trade. For the EURUSD it is always the same if you have a USD account: $0.10 for a micro lot, $1 for a mini lot, and $10 for a standard lot. For some other pairs it is different though. See Calculating Pip Value in Different Forex Pairs and Account Currencies.
Forex: $50 / (80 pips x $0.1) = $50 / $8 = 6.25 micro lots. Micro lots are the smallest trading lot with most brokers, so we can’t buy a partial lot. Therefore, we would round our position size down to 6 micro lots.
We know it is 6 micro lots because we used the pip value of a micro lot into the formula. To get the position size in mini lots, input $1 for the pip value instead. Doing so produces a position size of 0.625 mini lots, which is the same as 6.25 micro lots. The trade costs you $6,000 to make though (the value of 6 micro lots). To take the trade requires leverage.
Futures: Account Risk ($) / (Trade Risk in ticks x Tick Value) = Position size in contracts
Assume you have a $13,000 account, which means you can risk $130 per trade. You buy an E-mini S&P 500 (ES) contract at 1210.00 and place a stop loss at 1207.50, putting 10 ticks at risk (there are 4 ticks per point). You need to know the tick value of the contract you’re trading in order to determine the proper position size. For ES, each tick is worth $12.50.
Futures: $130 / (10 ticks x $12.50) = $130 / $125 = 1.04, or 1 contract. Holding a one contract position only costs about $500 in intraday margin (day trading) with many US brokers. If you hold overnight you’ll be subject to initial and maintenance margin. There is enough funds in the account to day trade this position or hold it overnight.
The Equal Dollar Amount Approach
I use another position sizing technique, typically in non-margined accounts like retirement accounts, etc.. Typically I am only trading stocks in these accounts.
In these types of accounts, I tend to accumulate longer-term trades, lasting weeks to months, or even years. Therefore, I don’t want to put all my capital in only a handful of trades, which often happens if using the 3-step approach discussed above.
Instead, I divide the account by 10 or 20, thus putting 5% or 10% in each stock I decide to trade. On a $200,000 account, I may put $20,000 into each stock. If there are a lot of possible trades out there, I may diversify a bit more and cut my account up into 20 positions, putting $10,000 in each.
Let’s assume I am putting 5% of my capital into each stock. On $200,000 account, that means buying $10,000 worth of stock on each trade. That doesn’t mean I am willing to lose all $10,000. That is just how much stock I buy. If the stock price is $25, I can buy 400 shares. If the stock price is $100, I buy 100 shares, and so on.
On each position, I still put a stop loss and control my risk. In order to take the trade, I need to reasonably expect that I can make at least make 2:1 on my risk. Typically I will want 3:1 or 4:1.
This approach is simpler for many people to understand. Buy a fixed amount of stock on each trade, and then set the stop loss wherever it should be for that trade. Make sure the profit potential justifies the risk. This is what my Stock Swing Trading Course is all about.
Equal Position Approach
I only use the equal position approach when day trading the same asset for extended periods of time. Whether it is a stock, forex pair, or futures contract, if I am trading it all the time I often use a default position size. Say 1000 or 2000 shares in a stock, or 10 contracts/lots.
This default amount, whatever you choose, shouldn’t expose your account to a more than 1% loss on each trade. While the odd trade may produce a bit more risk (and profit) than average, another trade will likely produce less, so over many trades it evens out.
With lots to think about in a fast moving market, a default position size is one less thing to worry about.
If it is a very volatile day, you will want to reduce your default size. If it is a very quiet day, you may want to up it slightly (or not trade). Therefore, a default position size doesn’t mean you don’t think about position size anymore. You still have to, you just don’t need to adjust it every trade.
Some assets work better with a default position size than others. Assets that tend to have similar volatility each day work well with a default position size. If it seems like you stop loss levels are very different on each trade, then a default position size won’t work well.
Proper Position Sizing Strategy – Final Word
The three-step method gives you the ideal position size for any market and any trade. When day trading you’ll need to quickly calculate your position size as you spot trades. Planning ahead will help in this regard, as discussed in How to Day Trade Forex in 2 Hours or Less. With a bit of practice, even when making trades on the fly, you should be able to nail the position size on your day trades every time. If swing trading, you have more time, so there’s no excuse for taking the wrong position size.
The method works for swing traders and day traders. Depending on which market you trade, master the formula. If you trade forex or futures, know your tick and pip values (or have them written down).
The equal dollar amount method works great for investor or swing traders in unleveraged accounts. There is less math involved because we always know how much stock (in dollars) we can buy. Then, we just set our stop loss and target on each trade.
Equal position size works for day traders who know the asset they are trading very well, and find that the distance to the stop loss on most of their trades is quite similar.
All these methods are work, although you may find one works better for your particular circumstance.
If you want to learn about day trading (or swing trading) successfully, check out the Forex Strategies Guide for Day Swing Traders eBook.
300+ Pages and more than 20+ strategies combined with trading psychology and a proven 5 step method for becoming a winning trader.
By Cory Mitchell, CMT @corymitc
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19 thoughts on “ How to Determine Proper Position Size When Trading – Any Trade, Any Market ”
Great article and very informative. I have been looking for the right position sizing for Futures trading and you have answered all. Thanks much. Do you have any blog on futures trading as well.
Thanks for the feedback. I primarily trade stocks and forex, so I don’t produce much futures content.
I have some questions that i can’t figure it out.
the question is in example : I have $1000000 and i will buy follow signal. Anyway i calculate trading size already. in the Bull market After the signal come out more and more my cash is running out untill my cash is running low and signal still come out I have 2 choices 1. Sell another stock(But still uptrend), 2.wait for the stock in my portfolio goiong to TargetPrice to sell and get in the new signal.
Please kindly advice
Hi Cory – for day trading when the market is less volatile and your SL and TP could be much smaller, for example 2 pip SL and 4 pip TP. Calculating the correct lot size for even a small account can result in large lot sizes. A $25 risk on a 2 pip SL results in a 1.25 lot or $125,000 for EURUUSD. In your opinion does using large lot sizes on low volatility like the example make it any more risky than a 10 pip SL at $25 on a more volatile trade that results in a .25 lot size or $25,000 for EURUUSD?
Yeah, i would say cap leverage at 20:1, and ideally be less than that. Any easy way to calculate this is to just always assume at least a 5 pip stop loss (and calculate position size based on that) even if you actually use a 2 or 3 pip stop.
So a $2000 account, can risk $20. Assume at least a 5 pip stop for the position size. So that means a possible trade of 4 mini lots (40,000), which means the trade utilizes 20:1 leverage.
The reason we want to cap our position size is in case of a surprise move (Trump says something and a pair that wasn’t really moving gaps 100 pips, creating a loss 20 times bigger than expected. Discussed here: http://vantagepointtrading.com/archives/20207. This doesn’t happen often outside of scheduled news releases (which we avoid when day trading), but could (and have) happened, so we gotta take some precautions to avoid that one catastrophic trade.
Also, to make it simple, you can also just pick a size a trade it all the time. Only if it is A LOT more volatile or sedate would you change it. For example, on a $2000 account you may opt to always trade 2 mini lots. This way, as long as the SL is less than 10 pips, you know you are risking less than 1%. Or maybe you trade 3 lots if most of your SLs end up being 6 pips (for this example). Since account balance doesn’t move a lot each day, typically you can trade the same position size for weeks, and make minor adjustments for increases/decreases in account balance and volatility ever few weeks.
All are viable methods, but yes, we want to cap our position size at some point.
Hi, Cory. Great information. Thank you for taking the time to write such informative articles and responses. Your generosity for aspiring traders is very commendable. Thanks to your articles, I’ve been able to realize many of my hangups.
Perhaps you, or one of your regular commenters, could help me with some of these questions.
1 – Assuming these conditions – a $50,000 account for trading stocks, 4:1 leverage ($200K) intraday, and opting to risk 1% of account ($500) per trade, with a chosen, fixed stop loss of $.10 from entry point, for any stock priced within a range to obtain 5000 shares (apprx. $40 per share or less).
If you were trading stocks intraday within these parameters, what fixed stop loss amount would you think is ideal? (e.g. $.10, $.12, $.15, $.20), again, assuming a stock priced near $40. Also assuming one is picking solid entries in first place of course (another topic), and not at random.
2 – I realize fixed stop loss amounts will vary based on share price ($.20 fluctuation for a $40 stock (.50%) is much more frequent/expected than $.20 fluctuation for a $4 stock (5%)).
Is there a fluctuation % you typically base your fixed stop loss amounts from when trading stocks intraday? (e.g. .3% of $40 stock = $.12, .3% of $67 stock = $.20) I’m thinking a .25-.30% move against a chosen entry is generally a pretty good indicator that a person’s assumption is wrong, with exceptions depending on the setup entry and timeframe.
3 – What is your opinion and personal preference on pyramiding, as a means to mitigate higher likelihood of stops getting hit, particularly in intraday trading and fast moving markets?
Additional Q – though unrelated to position sizing/stop losses.
4 – Based on your experience, do you think it’s possible to be successful intraday trading only 1-2 stocks in same sector for a long period of time (months or years), while ignoring all else, to include daily movements of the broader market (S&P 500), news, analyst opinions, etc.? And besides being merely possible, do you think such an approach is advisable? or would you say it is better to monitor a larger handful of stocks as well as the broader market intraday.
Thanks for you feedback John.
1. It depends on the volatility of the day and the stock. For a trade to take place, I typically wait for a pullback within a trend, and then for the price to consolidate during that pullback. Discussed in How to Day Trade Stocks: http://vantagepointtrading.com/archives/16708. I then enter when the price breaks out of the consolidation (in trending direction) and place a stop loss on the other side of the consolidation (occasionally I will enter during the consolidation). So my stop loss is based on the size of the consolidation. Typically these will be approximately the same each day for the same stocks, but may need to be adjusted by a penny or two.
2. I just use the method above. I am expecting the price to move in my favor after the consolidation breakout, so if it doesn’t, I will be stopped out. With this method I have no problem winning more than 60% of the time (and winners are bigger than losers), so no reason to get more complicated than that.
3. I typically do not pyramid. I would rather get in and out multiple times if there is a strong trend (assuming all opportunities provide the setup I am looking for and offer a favorable reward:risk ratio), locking in profits along the way.
4. For day trading, I think traders should focus on only a small number of stocks. I traded only SPY for a couple years (a good one for pretty much any time or any conditions). I traded only MCD for about a year. I traded only LULU for a long time. Now I mostly trade forex and I only day trade the EURUSD. Each week I publish a list of the most consistently volatile stocks. In that article, I recommend only picking 1 or 2 stocks and sticking with them (if you like volatile stocks, if not, find a stock or ETF that suits your trading style). Typically most fo the same stocks are on the list every week, so absolutely it is possible to trade only one stock…and its conditions can be favorable (for your strategy) for months or years. Then occasionally, you may need to make a switch, but not often. Only focus on the stock being traded, and not outside data (except be aware when news reports come out, and step aside for those). Focus on implementing your strategy in that one stock, and there is no reason to look at other data or input. This keeps trading very simple, which is good. When it is simple, it is easier to focus, and thus easier to trade better.
For swing trading I run stock screeners to find viable trades that meet certain criteria. In the forex market, I just have a list of close to 50 pairs that I scan through each day/week (depending on how often want to trade). I know exactly what I am looking for, so I can find and set my swing trade orders in less 20 minutes a night. So in swing trading I trade lots of different things, but for day trading I focus on just one stock/forex pair/futures contract.
Cory, thank you for the thorough response. I like your “keep it simple” approach. “Less is more” seems very applicable to trading.
Followup Q based on your response, do you ever make attempts to catch reversals at support/resistance points? Or just primarily focus on spotting/entering an existing trends during pullback / consolidation / continuation of trend?
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