Determining the proper position size before placing a trade can have a very positive impact on your trading results. First, position size can be adjusted to reflect the trade’s risk. Second, having strict limits on position size can help limit losses that are most likely to occur when you are beginning to trade.
To determine the correct position size, you must know two things: (1) where you’re placing your stop; and (2) the percentage or dollar amount of your account that you are willing to risk on the trade.
First up is where you’ll place your stop-loss order for the trade. Stops should not be set at random levels. Indeed, a stop needs to be placed at a logical level, where it will tell you if you’re wrong about the direction of the trade. Also, avoid placing a stop where it could easily be triggered by normal market movements.
Then, consider the size of your account and see if your stop-loss dollar amount jibes with the percentage you can afford to lose per trade. New traders are best off risking a modest 1%-3% of the account on a single trade, and as you saw earlier in Table 3, taking 1% risk on a $50,000 account equals $500.
Once you have a stop level, then you know the trade’s risk. For example, if your stop is 50 ticks from the entry price and each tick is worth $10, then your total risk for one contract is $500; if each tick were worth $5, then you could have a position size of two contracts and still maintain your risk at $500.