The definitive guide to perfect position sizing in trading

Position sizing a concept a lot of new traders overlook when they first start trading. They find out the hard way that position sizing is one of the most important concepts of being a successful trader. We emphasize on it strongly in our trading group. If you are serious about trading, you are serious about position sizing. But what is it, why is it so important and how does it correlate with risk and using a stop loss? How do you calculate your position size? Keep on reading and find out.

Key take aways

  • Position sizing refers to the amount of Bitcoin, Dollars or other asset you are trading with. If you get it wrong, it will always cost you money.
  • Nobody can predict the price so you are always exposed to a certain amount of risk. But you can determine this risk factor yourself
  • Together with your stop loss this risk factor determines your position size.
  • A stop loss is a fixed price that a trader determines that indicates his trade setup is invalidated. It protects your portfolio size and minimizes the loss.
  • You can calculate your position size with this formula: Position size = At risk amount / distance to stop loss
  • We have a great position size calculator you can use for every trade setup

What is position sizing?

Your position size is the amount you are trading with. It’s the amount of Bitcoin, USDT or other asset from your portfolio or trading capital you are putting in a single trade. If your position size is too large, you are risking too much of your portfolio when your trade isn’t working out. If it’s too small, you are leaving money on the table if your trade is going as planned. That’s why position sizing is so important: if you get it wrong, it will always cost you money.

So, getting it right is crucial. But how do you determine the right position size? Before we can calculate this, we first have to determine what risk in trading is, what risk factor you are comfortable with and what your stop loss is.

What is risk in trading?

Whenever you open a trade you are always exposing yourself to risk. No matter how good of a trader you are, the market sometimes does crazy things we cannot predict. Nobody has a crystal ball and can predict the future. The more you trade, the more you will come to realize this. It’s inevitable.

Risk in trading is the potential outcome that a trade doesn’t go as planned. Basically, whenever I think the price goes up, there is always a chance it goes down or vice versa. No matter how good my analysis is. I have two decades of trading experience and even I get it wrong sometimes. Knowing this, you can (and should) ask yourself the key question: how much of my portfolio am I willing to risk per trade?

This risk percentage could be 0.5% per trade, 1% per trade or even higher. This is your risk factor. The height of your risk factor is all up to you. There is no right or wrong in this, but for me it’s often between 0.5% and 2%. Depending on market conditions and my risk appetite.

Let’s illustrate this with an example. Say your risk factor is 1% and you have a portfolio size of 1 BTC. That would mean your position size per trade should always be 0.01 BTC right? Wrong! The 0.01 BTC is what’s called your at risk amount. It’s the maximum amount you are willing to risk per trade. But if the price of a certain coin drops 10% and you only want to risk a maximum of 0.01 BTC per trade. What should your position size be? You can only calculate this if you now the distance of the stop loss. Let’s find out what this means.

Continue reading below box.

Ed’s advice

I wouldn’t trade with a risk factor above 2%. Why? Let’s take a look at an example. If you have a risk factor of 10%, it would mean you are risking 10% of your trading capital per trade. If you are in 4 altcoin trades at the same time and BTC suddenly pumps, altcoin prices usually go down. Meaning your alt trades will hit their stop loss and you lose 10% per trade.

So now your trading capital is at a massive 40% loss. It’s hard to recover from this. Check the graph below. It shows the gains you have to make to recover from loss. Due to the magic of percentages, you can see it takes a 67% gain to make up a loss of 40%. The higher your loss, the more difficult it becomes to get break even. A risk factor of 2% max prevents this. You would have to have 20 losing trades in a row to lose 40% of your trading capital. Hence the first two trading rules from Warren Buffet. Rule 1: never loss money. Rule 2: don’t forget rule number one.

Notice it takes substantial more gains to make up a big loss.

What is a stop loss and how do you use it to calculate your position size?

You know that saying: hope for the best, prepare for the worst? A good trade setup always considers both and a stop loss is preparing for the worst. A stop loss is a fixed price that indicates a trade setup is invalidated. It’s the price level at which the reason to open the trade is proven wrong. For example when the price unexpectedly breaks a support and further downside is expected. Whenever you open a trade on an exchange you (should) also set your stop loss. In all exchanges the stop loss automatically triggers whenever the coin hits that price level.

Not using a stop loss is like not wearing a seatbelt: if a crash happens things get really painful.

Every serious trader uses a stop loss. It’s something we emphasize on every day in our group. Not using a stop loss is like not wearing a seatbelt: if a crash happens things get really painful. It protects your portfolio size and minimizes the loss. I’ve seen a lot of rookie traders not using a stop loss, it never ends well in the long run. Especially in a volatile market like crypto.

To illustrate what a stop loss is, let’s look at an example. You might have seen traders posting trade setups on Twitter like the picture below. https://www.tradingview.com/x/TWMc22cL/ (setup van Ed pakken!!)

The top of the green block is the target. It’s the price where the trader takes his (partial) profit. The intersection of the green and red box (the black line) is the entry price. The bottom of the red box is the stop loss. The difference between the entry price and the stop loss price is what’s called the distance to stop loss. This distance to stop loss changes in every trade setup. The reason being, every trade setup is different. Hence your invalidation point is always different. Sometimes your stop loss is 10% below your entry price or more. Sometimes it’s 1% or even less. The placement of your stop loss always depends on your analysis. You place it at the point your trading setup is invalidated.

But how does this affect your position size? It’s time to put the risk factor and your stop loss together and calculate your position size.

How do you calculate your position size?

Let’s do some math. The formula to calculate your position size is:

Position size = At risk amount / distance to stop loss %
At risk amount = risk factor x portfolio size
Distance to stop loss % = (entry price – stop loss price)/entry price*

Let’s again use an example to illustrate this. Say I have a portfolio size of 1 BTC and the risk factor I feel comfortable with is 1%. Using the formula above, my at risk amount is 0.01 BTC (1% x 1 BTC = 0.01 BTC).
Now say the price of a coin is 0.005 BTC and based on my analysis I think the price will go up. My analysis also indicates that if the price gets below 0.0048 BTC, I’m proven wrong and even more downside is to be expected. I place my stop loss at 0.0048. My distance to stop loss would be 0.04 or 4%. The calculation is (0.005-0.0048)/0.005 = 0.04.

Now we have everything to calculate our position size: 0.01 BTC/0.04 = 0.25 BTC. So for this specific setup my position size can be 0.25 BTC. If things go wrong and my stop loss triggers, I will lose 4% of 0.25BTC. And that is……you guessed it: 0.01 BTC.

*This is the formula for calculating the distance to stop loss for a long position. When going short the formula is (stop loss price – entry price) / entry price.

Position size calculator

It’s kind of a hassle to always manually calculate your position size. So, I made it easier for you and build a handy position size calculator. Just fill out the fields below and you are all set.

Continue your learning journey

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Cheers,
Ed