How to Position Size When Trading Stocks, Options and Futures

When trading stocks, options and futures, the goal is to have one of three outcomes: A big win, a small win or a small loss. The other goal is to avoid the fourth outcome, which is a big loss. That’s where position size comes into play.

Generally speaking, big losses come from one of two things. Either we ignore our initial stop-loss and let a small loss snowball so far that it becomes a big loss or we take way too big of a position relative to our account size.

Successful traders think “risk” first and “reward” second. There’s a reason it’s called “risk/reward.” They are more focused on what a particular trade will lose if things go wrong vs. how much they’ll make if things go right.

How the underlying asset will behave is out of our control. Those who blame “market manipulators,” bad luck and other reasons for their loss fail to look at themselves in the mirror. They need to form a strong trading strategy and set rules around that strategy.

Since the aforementioned “ignoring a stop loss” is more psychological, we want to focus on the more tangible part of the equation: Position sizing.

How to Properly Position Size When Trading

For me specifically, I don't like to risk more than 1% or 2% of my account value on any one trade. However, it really depends on:

1. What you are trading

2. How often you are trading

3. What your win-rate is

If we are day-trading and scalping 10-20 times a day, I would not personally risk 2% of my account value on each trade. If you’re off or your strategy is not performing well on a particular day, you could shred your account to pieces in a matter of days — or hours!

Let’s consider a swing trade, regardless of instrument.

If you have a $100,000 account, it would be reasonable to risk $1,000 to $2,000 on your trade. Less is fine! However, more and it starts to become risky over longer stretches of time.

Keep in mind, this is not the size of the trade, but the size of the risk. With that in mind, it becomes an equation. Take this example:

• Account size: $100,000

• Preferred risk: 1%

  • Risk = $1,000

The rest of the equation is our entry price and our stop-loss point. Adding those into the scenario will tell us our position size. For our example, we’ll use the SPY ETF.

• SPY Entry: $410

• Stop-Loss: $403

  • Risk = $7 a share.

With those data points, we are risking $1,000 on the trade and $7 a share in the setup. So, $1,000 (account risk) divided by $7 (per share risk) gets us 142.8 — call it 143 shares.

That’s 143 shares of SPY that we can swing given our risk profile.

If you adjust the numbers, it alters the outcome.

• If we are risking 2% ($2,000) instead of 1% ($1,000), we could swing about 285 shares ($2,000 divided by $7 equals 285 shares with a $7 risk).

• If we keep the 1%/$1,000 risk profile, but have a wider stop-loss — say $10 instead of $7 — that cuts our position size down to 100 shares ($1,000 divided by $10 equals 100 shares).

Why Position Size Is Important

We already know the long-term performance of the market favors one side, the bulls. However, trading is very different and requires much more precision, which is why position size is so important. Too many traders overlook this part. Sometimes that’s from inexperience, other times it’s from ego.

First, with proper position size, you should be able to trade with less emotion. Too large of a position and our emotions go haywire. That’s as the gains and losses are far too big for our given account size.

The second and likely more important consideration is the drawdowns.

In trading, there will be periods when the environment is conducive to our trading style and periods were it’s not. No trading strategy thrives in all environments, unfortunately.

When the environment is favorable, we can justify operating with a larger position size. Conversely, when the environment is not favorable, we should be trading with smaller size.

If we are risking 5% of our account on any one given trade, five straight losers will deal a painful blow to our account. Five straight losses at 5% of account value at a time, leaves us down about 22.5% on the account.

To regain those losses, we now need a 29% return!

Anyone who’s been in this game for more than five minutes knows how easy it is to hit five straight losses.

If we risk 2% per trade and lose five times in a row, we still have more than 90% of account value to work with. Further, we need a gain of “just” 10.6% to return it back to B/E.

Applying Position Sizing to Your Strategy

If you follow that example, the account would be down about 7.5% after five straight losses (2% risk on the first three trades, and 1% on each of the next two losses).

Of course, you could risk less than 2% per trade initially. Environment is key. I know I keep saying that, but it’s true. If we’re in a choppy market or a volatile bear market, our trading size should be smaller to account for this. If we’re in a trending bull market, we can size up to the higher end of our position size preference.

I generally risk 1% to 2% per swing trade. In strong trending tapes, I lean toward 2%. In choppy, tough environments, I go toward 1%.

Notice this example from the Opening Print on the morning of March 28th:

While this sequence worked incredibly well for our members, position size in this scenario was key and was the main focal point of our discussion.