Position Sizing and Risk Management
Position Sizing and Risk Management
For Day Traders
How to Think
Day trading is unlike any trading you have done before. It is not investing. It is trading. Your thinking must change from a mindset of investing money in a quality asset to grow over the long term to one of using money as a tool.
Investors
When investing you may take an example portfolio of 100,000 and divide it into equal positions such as ten 10,000 positions and invest those. You likely never set stop losses and simply add to these ten positions as time goes on. You watch your portfolio flow with the market and typically grow over the long term.
How is Day Trading Different?
When day trading you do not really have a portfolio. You are not investing. You are risk a known amount of money to either win or lose before the market closes for the day. A day trader is likely to only be in one to three positions at a time. The more positions the more attention is divided rather than looking for the next opportunity.
Risk Management
Let’s look at the same example of 100,000. Rather than dividing this up into positions, a day trader will agree on a set amount they are willing to lose on each trade. I use 0.5% of my account value when I start each day. For a 100,000 account that would be $500. If I make 3 trades in a day that go against me and get stopped out, I have lost $1,500. I might would walk away for the day and try again tomorrow with $98,500 and risk $492.5 on each trade that day.
Position sizing
When an opportunity is presented, you think ABC is due to run up a bit. The Risk Management example above has granted you $500 to risk losing out of your $100,000 account. How much of ABC do you buy? ABC is currently trading for $5.36. You have figured out that there is support at 5.19 and resistance at 5.90. To properly size your position such that if it drops below 5.18 you are stopped out and only lose $500 we need to figure out the difference between your entry price of 5.36 and your stop price of 5.18, which is $0.18. We then take your $500 risk and divide that by $0.18 which is 2,777. The proper position size is 2,777 shares of ABC at a purchase price an entry price of $5.36 and a Stop Loss price of 5.18. If 2,777 shares lose $0.18 of value, you will lose 2777 *.18 = $499.86. If you buy 3000 shares instead and you get stopped out at 5.18 you will have lost $540 which is above your risk tolerance. At $5.36 a share the 2777 share position will have a total value of $14884.72.
The #1 thing to remember is controlling the losses. You do this with Risk Management and Position Sizing.