Capital Management – Position Sizing
Today we look at step three of our series on capital management
- Determine your risk sizing
- Identify your stop price or where you will exit if the trade goes against you
- Calculate your position size
- Examine the risk/reward profile of the trade before entering
Calculating your position size is probably the easiest step in the process, but still a vital one. Getting your position size correct – along with you stop loss and risk sizing – will ensure that you don’t commit too much capital to any one position.
Furthermore, so many people simply don’t know how many shares to buy. Often, it’s simply a nominal amount ($1000 for example) dividend by the share price. That won’t work if you are implementing a capital management strategy with stop losses.
What do we know so far?
Based on the previous articles, we’re assuming a $100K account size, with a 2% ($2K) risk sizing. Now let’s consider the CDA example from the last article.
- Entry price at 846c and stop loss at 717c
- That’s a difference of 129c between the entry price and stop loss price
- The risk, if we buy 1 unit of CDA at 846c and get stopped out at 717c, is 129c
- To figure out how many units to buy, we divide our risk size ($2K) by 129c
- $2000 / $1.29 = 1550.387596899225 units
- Round it off at 1550
- 1550 units x $8.49 entry price = $13,113 – this is our actual position size
Now we can make the following statements;
- If I buy 1550 units of CDA at 846c – a position size of $13,113 – and get stopped out at 717c, I will lose $2000, which is 2% of my overall trading account.
- That is within the parameters of my capital management strategy and I can proceed (provided step number four is valid, which we will discuss next week).
That’s it team, pretty simple. If you have been following the articles on capital management, hopefully this calculation ties the steps together.