Calculating the amount of a currency, commodity, or stocks is a commonly overlooked task in the art of cryptocurrency trading. Traders usually make a wild guess or an arbitrary decision regarding position size. This may come from their hunches or instincts, inexperience, or whenever they feel confident about their trading strategy. They take bigger positions when they feel like it or sometimes opting for smaller positions when they feel less complacent. This behavior is reckless and may not be logical. There are a lot of things that should be considered during position sizing to minimize risks brought by market volatility.
In this blog, we are going to shed light on position sizing, its importance, strategies, and how to construct your own position-sizing model. Keep reading to find out.
Position Sizing refers to the method of determining the trade size invested in specific security by an investor or a trader. A lot of beginners make mistakes when it comes to trading, particularly taking over big positions. Their errors end with certain and irreversible losses.
Position Sizing is crucial because it can affect your trading performance and future success. If you tend to opt for a small position size, then you can also expect a small outcome. On the other hand, if you are “position sizing” recklessly, you are increasing the risks of destroying your trading account along with your funds. You need to strike a balance between the two to achieve substantial returns at an acceptable risk level. Always remember that the downside is always capped and wrapped at 100% whereas the upside is infinite.
So, what position sizing strategies can you use to minimize risks and ensure that you can still hold your ground?
Since position size is determined by the stop loss, it is crucial to know where they should be placed. Select approaches in placing stop losses include: (1) Around resistance and support levels; and (2) adjusting the stop loss based on market volatility.
Resistance and support levels are specific zones where the market tends to regress. Placing a stop loss above or right under a resistance or support level, determined by your targets (whether you are going short or long), is one widely used approach.
On the other hand, even if you do not opt for a volatility-based position sizing strategy, you must take into consideration the level of market volatility. Placing stop losses too near to the entry will put an end to your trade before the market has the chance to decide the direction of your trade.
The finest stop loss distance for a market can be settled by either observing the ATR indicator or backtesting the trading strategy.
To achieve your crypto trading objectives, here are some pointers you need to take note of:
First, you should construct your position sizing strategy according to your specific objectives for both your: (1) targeted return; and (2) maximum acceptable drawdown. For instance, when you construct a position sizing model, you need to specify your desired returns per year and your desired optimum drawdown. You can freely set your goals as low or high as you like. When you are marking these targets, always make your reward/risk asymmetrical. It means that the return goal should be larger than the drawdown goal and returns are expected to be skewed leaning more on the upside.
You need to have a vision of the results in terms of how many trades it will generate and how many wins vs losses. You also need to take into consideration your major losing streaks, and how much possible profit you can make per trade. You can track this by reviewing at least your last 30 trades (to be statistically significant). However, if you do not have these results, it is totally fine to come up with another plausible and attainable objective.
Once you have established and set your objectives, you can start by working out how much you want to risk on each trade to determine your position size. For instance, if you are risking a hundred dollars or 1% of your trading account, you need to decide about the position size you should trade based on when and where you are placing your stop loss. You can freely increase and decrease it until you reach your desired threshold. This particular step requires some trial and error but creates both a financial and psychological safety barrier against possible mishaps.
You can pull this off via demo trading or live trading or any reliable position-sizing game that can be accessed online. In simulations, you can determine the inputs and your position size, compute costs and errors, and see if your strategy works well in attaining your objectives. However, in reality, trading does not operate like a simulation, so you need to take your evaluation results as indicative, not infallible precursors.
Always be prepared to accept and adapt to changes depending on what is offered.
There are numerous strategies and ways in helping people to achieve their goals in cryptocurrency trading. However, position-sizing, like any other strategy, are just mere guidelines and indicative statistics for you to grasp the art of trading.
Most of these models require absolute compatibility with the individual’s circumstances, personality, and resources. A widely used approach does not indicate success, and things will not always work the way you wanted them to, so you always must be open to alternative channels, feasible options, and infinite possibilities. Always bear in mind that you should only risk what you can afford to lose.