90% of new traders will lose 90% of their account within 1 year. Why?
In life, there is always an ideal portion or amount of any good thing. Beyond that threshold, things can get dangerous. I love ice cream. When consumed occasionally, there is no health threat. Having one every day will be disastrous. It is the same for trading. Risking too little money and you will be miserable. Risking too much each trade will lead to disaster.
There are 3 Ms to becoming a consistent and successful trader. In the previous articles, you have read about the Methods (the first M) I employ and the mindset (the second M) I adopt. The third M is Money; the amount to risk per trade.
What’s the optimum amount to risk each trade? Enter position sizing.
#1 The Golden Formula For Position Sizing
There are only 3 things you will ever need to know:
#1 Position size: The number of shares you should purchase (or sell short)
#2 Stop-loss budget: 1-5% of the amount you allocate for this trade
#3 Dollar risk per unit: The difference in dollar amount between the price of the stock and the stop-loss level
#2 Steps to calculate the optimum number of shares
#1 Set a Stop-Loss budget equating to 1% – 5% of your account per trade
#2 Determine your stop-loss level based on your methods
#3 Divide #1 by #2
Confused? Don’t worry. Check out our position sizing calculator designed specially for you.
“But, I get to make more if I risk more and the trade goes in my favor”. That’s a huge assumption! What if the trade you took with a larger risk doesn’t go your way? Are you prepared to lose that amount of money? How badly will that loss affect your trading capital?
#3 The Reality Of Losses
By June, you are left with $5,000. That’s 50% of your original capital of $10,000. To get back to the original trading capital, you need to make 100%. Position sizing along with the right mind and methods will prevent a horrific drawdown, leaving you with a mountain to climb.
Fear and greed cause people to do silly things which will be regretted. Including position sizing into your trading can reduce heartaches and regrets, leaving you with less stress and more cash to trade another day. After all, slow and steady wins the race!
Head back for our next article on where I bring everything together by designing a trading plan. Till then, join our Facebook and Telegram community where we share ideas, news and more regarding stocks, indices and currencies.
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