In the last risk management chapter I explained to you the importance of the 1% rule. You should understand by now that if your account size is $10,000, you should only risk $100 per trade according to the 1% rule.
The 1% rule leads us to the next question - "How do I calculate the position size so every trade is risking exactly $100?"
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What is position size?
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Position size refers to the size of a position. 'It allows traders to have a fixed amount of risk per trade regardless of how big or small the market movement.'
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Position size formula
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Example
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Let's use an example so you can understand better.
Let's assume we are going to buy BTC at $7,000 and we decide to place our SL below key support level at $6,000 .
According to the formula, the Distance to SL would be ($7,000 - $6,000) / $7,000 = 0.1429.
Since we have already assumed our risk amount to be $100 per trade, the Position size in this example is thus equal to $100 / 0.1429 = $700
This $700 is the position size that you enter when placing the trade. If BTC hits our SL at $6,000, we will make a loss of $100. This is exactly what we want (ie. risk a fixed amount of capital per each trade).
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Position size vs Leverage
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At this point, you must be thinking – “why is leverage not part of the equation to calculate the position size?”
Well, contrary to what many think, leverage does NOT have an impact on the position size. Instead, leverage allows you to open a larger position size that you wouldn’t have been able to if without leverage.
Selecting higher leverage means that the trader uses smaller capital to open the same trade as another trader who uses larger capital at lower leverage.
In saying the above, this does not mean you can use the maximum leverage available just because it does not have an impact on the position size. This is because you still need to ensure your stop loss level is set at a level that will get triggered before liquidation.
Hope you have enjoyed this article.
Give this article a LIKE to support for further free educational materials on risk management !
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
Risk management series:
Chapter 1 - 1% rule
The 1% rule leads us to the next question - "How do I calculate the position size so every trade is risking exactly $100?"
~~~~~~~~~~~~~~~~~
What is position size?
~~~~~~~~~~~~~~~~~
Position size refers to the size of a position. 'It allows traders to have a fixed amount of risk per trade regardless of how big or small the market movement.'
~~~~~~~~~~~~~~~~~
Position size formula
~~~~~~~~~~~~~~~~~
~~~~~~~
Example
~~~~~~~
Let's use an example so you can understand better.
Let's assume we are going to buy BTC at $7,000 and we decide to place our SL below key support level at $6,000 .
According to the formula, the Distance to SL would be ($7,000 - $6,000) / $7,000 = 0.1429.
Since we have already assumed our risk amount to be $100 per trade, the Position size in this example is thus equal to $100 / 0.1429 = $700
This $700 is the position size that you enter when placing the trade. If BTC hits our SL at $6,000, we will make a loss of $100. This is exactly what we want (ie. risk a fixed amount of capital per each trade).
~~~~~~~~~~~~~~~~~~~~~
Position size vs Leverage
~~~~~~~~~~~~~~~~~~~~~
At this point, you must be thinking – “why is leverage not part of the equation to calculate the position size?”
Well, contrary to what many think, leverage does NOT have an impact on the position size. Instead, leverage allows you to open a larger position size that you wouldn’t have been able to if without leverage.
Selecting higher leverage means that the trader uses smaller capital to open the same trade as another trader who uses larger capital at lower leverage.
In saying the above, this does not mean you can use the maximum leverage available just because it does not have an impact on the position size. This is because you still need to ensure your stop loss level is set at a level that will get triggered before liquidation.
Hope you have enjoyed this article.
Give this article a LIKE to support for further free educational materials on risk management !
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
Risk management series:
Chapter 1 - 1% rule