Trading with TrendLine Dynamics Charts

Position Sizing

Position size has to do with how much money you should risk on any given position. Trading coach Dr. Van Tharp is the person who coined the term position sizing. He defines it as follows:

Position sizing is the part of your trading system that tells you how many shares or contracts to take per trade. Poor position sizing is the reason behind almost every instance of account blowouts. Preservation of capital is the most important concept for those who want to stay in the trading
game for the long haul.

For example, if you have $10,000 in your trading account and you understand that risking more than 2% on any one position is a dangerous thing to do, then you can risk $200 dollars on each position.

A simple way of thinking about position sizing is that position size equals risk. If that works for you, that's fine and it will certainly keep you from over-committing to any one position. It doesn't have to be any more complicated than that.

If you're ready to take on some calculations that are a little more complex, you can add your initial protective stop to the mix. Consider the following hypothetical situation:

Stock MSPF (Mama Sterrata Pasta Farms) is selling for $100 a share. One of the rules of your trading system requires you to put a sell-stop on a position that will automatically get you out if the stock drops by 20%. That means that your maximum risk will $20 per share. So your risk with a 20% stop is $20 if you buy 1 share, $40 is you buy two shares, $60 if you buy 3 shares, and so on. So if you buy 10 shares your risk is $200. Since 2% of $10,000 is $200, that means you can buy 10 shares. So with a 20%
stop, your risk on 10 shares is $200, even though your total position size is $1000.

If this makes sense to you, then use it. Otherwise just stick to the simpler way of thinking about it where position size equals risk. It is safer and you can always shift to the more complex method later.

See Van Tharp's page on position sizing for more information.



Continue to the next article in the series: Closing Thoughts

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