Position Sizing Can Limit Trading Losses

Many seasoned traders know that position sizing or determining the size of each trade is a vital part of any trading plan. Many beginner traders however make the mistake of not paying adequate attention to this step. They believe that it is enough to simply define the initial stops. This however is a very incomplete way of trying to manage your risks.

Determining the size of every trade is crucial for the protection of your trading float. When you are certain about the number of units that is ideal for you to deal with, you are protecting your capital from getting eroded. Moreover, when you fully delve into proper position sizing, you are also able to identify your win and loss potentials.

What many investors don’t realize is that size matters. The amount that you put in is the indicator of how much you might earn or lose. The more units you purchase, the higher your chances of winning. This is why some immediately invest a lot, thinking that the more risks they take, the more rewards they get. Deciding on this factor however based only on the opportunity to profit well is not advisable. Remember that a big investment also magnifies your chances of losing. To arrive at the best option for you, your risk management system should incorporate a scientific way of defining the extent of an investment.

Getting the right guiding figure to enter a trade isn’t as complicated as you would imagine. You simply have to divide your already predefined maximum loss in dollars by your stop size. The result is the maximum number of units you should purchase on a single trade.

To settle on your maximum loss, identify the percentage of your float that you can bear losing. It is perhaps most sensible to settle for a loss of about 2% because this is neither too small nor too big. To identify your stop size, get the difference between the entry price and initial stop.

In some cases, you may need to further refine this part of your risk management strategy. Depending on your tolerance for risks, you may still view the resulting size as too huge for you. In this case, it would be wise to add another rule to keep your investment money safe. You can set a maximum percentage figure that corresponds to a specific dollar value over which you are not willing to lose. You can say for instance that you are not willing to lose more than 20% of your total float. Hence, if the result of your initial size calculations goes over this, you can follow your extra rule to further scale down your purchase of units.

Position sizing may seem like a technical trading step. In reality though, it is just a sensible way of making sure you don’t drown with the weight of your losses. Do not consider trading without paying due attention to this step. Put as much importance on it as you would on identifying your stops and the size of your float.

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Is Options Trading a Risky Business?

Most people consider options trading a risky business. While it is true that no investment is without risk, it is possible to limit or manage your risks, just as you would with any business.

If your option strategies are more like betting or gambling, if you follow some sort of intuition or sixth sense, then you will lose money. If your strategy is to think of options trading as a business and you know about managing a business or you are willing to learn, then you can make money.

Any business owner looks at the cost of goods and the potential profits to be made. In other words, what an item can be purchased for and what it can be sold for. Investments should be looked at in the same way.

A business owner must also be willing to look at how much loss is affordable and acceptable. There will always be items lost or broken during shipping. Someone is likely to drop that crystal goblet and break it before it goes into the box. But, when an item is simply too delicate to handle, there will be too much breakage, too much loss and a business owner will probably decide not to sell that item.

If you are new to the “business”, it is a good idea to learn the option strategies used by experienced investors. There are plenty of investors out there willing to teach you their system for a price.

There is a great deal of free information, too. But, this is truly one of those situations where you get what you pay for. No truly successful investor will tell you everything there is to know about his option strategies for free. Why should he?

But, before you buy a book or download an e-book on the subject of options trading, do a little evaluation. Ask some questions to make sure that you are not wasting your money.

First, is this a system that works, regardless of the economy? There are profitable option strategies that work regardless of the state of the economy. This is not like the stock market, although it is affected by it.

Second, is this a get-rich-quick scheme or real education about managing this kind of a business? Is the system based on business fundamentals, such as profit, loss, expenses, overhead and return-on-investment?

After reading this article, you should know what the answers to those questions should be. You are looking for an options trading business, not a scam.

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