Position sizing is a simple calculation of how much money you are willing to lose in any one trade. Most new traders don't even think about this very question. Instead they just focus on the potential profit a trade may give them. When the S#@#$ hits the fan suddenly they are caught like a deer in the headlights and their minds freeze up as what to do. I have been there and its the worst thing, wanting the trade to go back up (or down if short) only to see it keep going against you and the losses getting bigger and bigger. This is not what you wanted when you placed the trade and taking the loss gets harder and harder as it gets bigger and bigger. It's a catch 22 situation.
The way to avoid this is by knowing in advance how much you are really willing to lose, and if you do lose that trade, is your trading capital still intact to trade again.
The formula is this the amount you are happy to lose divided by the distance from your buy price to your stop price. eg I want to buy stock XXX at 1.10 and my stop loss is at 1.01 I am willing only to lose $200 if the trade goes wrong. So how many shares do I buy?
The answer is $200/.09 = 2,222 shares.
Now as long as I have a hard stop loss in place (sitting in the market) my chances of getting runover is reduced greatly. If the market does gap open below my stop I still will be in a better position to cope with the crisis as my losses will still be within a reasonable range eg, $200 -$500.
Now, the easy way to calculate this is to use a handy little app that does it all for you and has 5 other models to work out position size and risk. If you fill out your details in the right hand column I will send you the link. YES its FREE and its a professional level tool. It really helped my trading.
