Determination of Position Size Depending on Risks. Risk Management.

Info
07/07/2019

Experienced traders do not doubt that the right choice of position size can significantly affect the profitability of trading while opening too large positions can cause a significant drawdown of the deposit. Many beginners don’t realize the importance of risk control.

What do we mean by risk? Risk in trading is the value of the maximum loss expressed in absolute or percentage related to the size of the deposit that the trader can get in case of unfavourable developments. We should distinguish between the risk position and risk on paper. The risk on paper is usually determined by the chart and represents the distance from the position opening level to the level of a stop order. The risk on the position relates this value to the size of the trader’s deposit and shows which part of the deposit will be lost if the position is closed with a loss.

Every experienced trader understands that there is no such thing as a 100% guarantee of profit. You can have 2, 3 or even 5 losing trades in a row, until you can catch the movement and take a substantial profit. During this time, a strong drawdown of the deposit must not be allowed. Therefore, everyone knows the maximum risk that he/she can take in a separate transaction. Also, the size of the position is calculated depending on the size of acceptable risk.

Use of money management in calculating risk

So now let’s talk about how the trader knows what size of risk per position should be put into account. There is a boring science called “money management.” It is boring because it’s based on the statistical processing of a large amount of data. The main thing is to understand the idea. So the idea is as follows: if we open positions with a very small volume, we will have a fairly modest profit, but the drawdown of the deposit will be very small. So far, everything is logical and unobjectionable. If we increase the size of the opened position, the profitability will increase until some time — it is also logical. However, most traders don’t know that when the size of the position exceeds some critical value, the profit begins to decrease, and may even turn into a loss.

Serious science of money management studies ways to determine the optimal size of the opened position, giving maximum (“optimal”) profit. The optimal size of the opened position will be different for different trading systems and traded instruments. It can be calculated only employing statistical processing of the results of its trade. Ten transactions (as in the example above) will not be enough. In statistics, only a sample consisting of at least 30 results is considered reliable. And the larger the sample, the more reliable the result. Therefore, most experienced traders always carry out the so-called “paper testing” (the scrupulous study of the system operation on past data) before trading on a new trading system or making amendments to the existing trading system. Some people limit to the intuitive position sizing, gradually increasing the size of the position until they note the deterioration of results. In any case, a trader who wants to get stable results in the market necessarily keeps a log of his/her transactions and analyzes them after the accumulation of a sufficient number of records, making necessary changes in the size of the position opened and in the decision-making system.

Don’t repeat the mistakes of the losers! Remember that trading is profitable only for those who take it seriously and understand that in order to always make money on the market, you need to become the best among many and constantly improve your knowledge and skills. The market always rewards traders for their hard work. 

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