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Position sizing: A crucial strategy for traders to survive the ups and downs

by , 08 April 2014

When you trade, you need sound money management principles in place. Otherwise one big trade that doesn't go your way could leave you out of trading funds. That's where position sizing comes in. It ensures that you don't risk too much on one trade. And if the trade flops, you'll still have enough money in your trading pot to continue. Let's take a closer look at position sizing…

What is position sizing?

Position sizing is an essential element of trading success. But not managing the size of your positions, you’re setting yourself up for large losses.

Position sizing if a trading strategy that tells you how much money you should put in a single trade, Brian Hunt in S&A Digest explains. By using position sizing, you protect yourself from catastrophic losses. A catastrophic loss is when you put a large proportion of your trading capital into one trade and it goes wrong.

A catastrophic loss doesn’t just hit you in the pocket, it can scar you mentally too. It can really hit your trading confidence.

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How to choose a position size

The best way to keep your risk low is to put 1% of your trading capital into one position. The higher your position size, the higher your risk.

So if you have a pot of R100,000 for trading, 1% of that is R1,000. This means you shouldn’t risk more than R1,000 in each trade you enter.

If you decide a particular trade is less risky, you could increase your position size to 2% for instance. Using the example above, this would increase your trading capital to R2,000.

As well as using position sizing, you should also be using stop losses to protect against a trade going against you. This is a predetermined price you decide on before you enter a trade. If your trade hits this level, you exit.

So there you have it, a crucial strategy for traders to survive the ups and downs.

Position sizing: A crucial strategy for traders to survive the ups and downs
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