How Position Sizing Strategies and Goals Helped Me Meet My Crypto Trading Objectives

How Position Sizing Strategies and Goals Helped Me Meet My Crypto Trading Objectives

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.

What is Position Sizing?

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.

Importance of Position Sizing

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?

Best and Most Common Position Sizing Strategies

  1. Fixed Dollar Amount: This is considered as one of the easiest position sizing strategies. You just need to think of an amount you are willing to risk and adjust your number of contracts or stocks accordingly. The number of stocks you can buy is entirely dependent on where you placed a “stop loss”.
  2. Fixed Percentage Risk: This position sizing strategy is almost identical to the fixed dollar amount approach. However, in the fixed percentage, we utilize a percent-based risk instead. A lot of traders tend to curb their optimal risk to a few percentage points but risking not more than 2%. One of the advantages of using fixed percentage position sizing as your strategy is that your position size automatically adapts to your account size and your account will grow bigger because of compounding.
  3. Volatility-Based: This strategy uses a specific scale of volatility to decide an appropriate position size. Market volatility changes from time to time, and with greater volatility comes greater swings, which should be noted and remembered. For instance, a trader can use ATR or Average True Range in determining the market volatility.
  4. Fixed Risk Per Trade: This position sizing strategy is quite complicated as it uses three different variables in determining the position size, namely: (1) stop loss for the total trade value; (2) risk per trade as a percentage of account equity; and (3) the maximum risk for the trading account as a whole. With this approach, there is no limit on how many risky trades will be executed as it removes risk by placing a cap on the optimum portfolio risk.
  5. Kelly Criterion: This classic formula is developed by John L. Kelly, a scientist who worked for Bell Labs. This time-honored formula is used by both gamblers and traders in determining the position size for every bet/trade. The primary advantage of the Kelly Criterion is that it takes account of the history and performance of your trading strategy and put it into consideration. Thus, the position size can be easily adjusted accordingly.
  6. Averaging Down: This position sizing strategy is somewhat risky and should be utilized with caution. Averaging down is mostly used with mean-reverting strategies. It requires you to keep adding shares/contracts if the market moves against you so you can reduce the average price and decrease the amount that the stock must rise for you to profit.
  7. Maximum Drawdown: This position sizing strategy is widely used by traders when making portfolios. It works by combining numerous systems to find unrelated strategies that can increase and maximize the drawdown-to-profit ratio. However, please keep in mind that this strategy is not completely. Usually, you must at least double or increase the historical drawdown to make decisions during live trading.
  8. Monte Carlo: This is a well-known simulation method that functions by taking all the trades in backtest as it randomly changes their order. With this strategy, you can statistically measure the likelihood that an upcoming drawdown will recline into a specific amount. This method is also regarded as a continuation of the Maximum Drawdown strategy because they similarly take account of upcoming drawdowns that are likely to surpass historical data.

How to Know Where to Put the Stop Loss

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.

Constructing Your Position Sizing Strategies

To achieve your crypto trading objectives, here are some pointers you need to take note of:

What are you trying to achieve?

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.

Next, you need to know your trading system performance.

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.

How much should you risk on each trade?

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.

Finally, test and evaluate your position sizing strategy.

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.

How These Strategies and Goals Helped Me Trading Cryptos

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.

About the author

Hi I'm Jeff Kiefer and this is my blog. I've been in the Internet Marketing industry for over ten years now, and I would like to share all my experience, insights and other fun stuff with you guys!

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