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 the quick process works for any market.
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 phenomenal returns. See: How Much Money Can I Make as a Day Trader.
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 (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 not wish to risk even 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 opt to only risk $4,000, for example. $4,000 is less than 1% so it’s a suitable figure, and is the account risk ($) 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.
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 a 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 $5000 account, which means you can risk $50 per trade. You buy the EURUSD at 1.1500 and place a stop loss at 1.1490, making your trade risk 10 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 / (10 pips x $1) = $50 / $10 = 5 mini lots. We know it is 5 mini lots, and not micro or standard lots, because we punched the pip value of a mini lot into the formula. To get the position size in micro lots, input $0.10 for the pip value instead. Doing so produces a position size of 50 micro lots, which is the same as 5 mini lots. The trade costs you $50,000 to make though (the value of 5 mini lots). To take the trade leverage of at least 10:1 is required.
Futures: Account Risk ($) / (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. Maintenance margin on this contract is $4600, subject to change, and expect to pay $5060 (may vary) in initial margin. There is enough funds in the account to day trade this position or hold it overnight.
Proper Position Sizing Strategy – Final Word
This 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 nail the position size on your day trades every time. If swing trading, you have much more time, so there’s no excuse for taking the wrong position size.
The method works for swing traders, day traders or investors. 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) if you need to make trades quickly. If you’re swing trading, again, you have more time so you can look them up as needed.
Over time you’ll quickly determine your position size as trade signals occur. Whether you risk 1% or less (recommended)–or choose to risk a fixed dollar amount which is less than one percent of your account–these three steps provide you with the ultimate position sizing strategy, fine-tuned for your account size and each trade.
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
Other articles to Read:
Analyzing Price Action: Velocity and Magnitude – Two of the most important facts when analyzing price action. Can help assess probabilities of trades and therefore help to filter or confirm upcoming trade signals.
How to Use Trendlines For Trading – Dispelling the Myths – Article with a video which explains how to use trendlines, their drawbacks and their uses, how to re-draw them and why studying price action must always be used in conjunction with trendlines.