Position sizing refers to the number of shares, lots or contracts that will be placed with each trade. Two methods are commonly used by traders: Constant position sizing and fixed percentage position sizing. Constant position sizing uses the same amount of shares or contracts for every trade, while fixed percentage position sizing varies the position size as the value of the account changes. Position sizing is a critical consideration; it is a vital element in any trading strategy.
Preservation of capital is essential to long-term success in trading: You cannot continue trading if you’ve blown through your trading account. As such, it is important to start with small position sizing. Positions should be increased only after the strategy has provided consistent results during live trading for a meaningful period of time (at least several months).
Responsible risk management involves responsible position sizing, thoroughly and accurately testing a strategy before risking real money and limiting the amount of money that is risked on any one trade.
As you develop trading strategies, it is important to remember that any strategy can be turned into the holy grail on paper through poor testing practices and over-optimization; equally important to remember is that these curve-fit strategies likely will fail in a live market. Creativity and solid observation are more effective than blindly optimizing to achieve the best numbers.
An important advantage in having a trading strategy is that it can be automated so a computer monitors the markets for trading opportunities and executes the trades. Many traders find strategy automation beneficial to their trading because it keeps emotions in check, preserves discipline, improves order entry speed and accuracy and allows traders to achieve greater consistency.
Jean Folger is the co-founder of, and system researcher with, PowerZone Trading, LLC. Jean can be reached at www.powerzonetrading.com.