When you begin trading stocks, you need to consider your position size. It is the number of shares you buy or sell at any time. Position size is important because it can impact your risk.
If you have a short position, your risk is limited if the stock price moves against you. However, your risk is much higher if the stock price moves against you if you have a significant position.
Most traders use a risk management system that includes position sizing as part of their overall strategy. It ensures that they are always taking appropriate risks and not exposing themselves to too much risk at any one time.
Decide on your risk tolerance
Your risk tolerance is the amount of money you are willing to lose in any trade.
Some traders decide on a percentage of their account size as their risk tolerance. For example, if you have an account size of £10,000, you might decide that you are comfortable risking £100 per trade.
Others might decide on a fixed amount of money they are willing to lose. So, if you have a £1,000 account, you might decide that you are comfortable risking £50 per trade.
Once you have decided on your risk tolerance, you need to stick to it. It is imperative not to exceed this amount, as it can lead to disastrous results.
Calculate your position size
Now that you know your risk tolerance, you need to calculate your position size.
The formula for calculating your position size is: Position Size = (risk tolerance/share price) x number of shares.
So, if you have a risk tolerance of £50 and the share price is £2, then your position size would be: Position Size = (£50 / £2) x 100 = 2500 shares.
If the share price were £1, your position size would be: Position Size = (£50 / £1) x 100 = 5000 shares.
It is vital to use the current share price when calculating your position size as it ensures that you are always considering the current market conditions.
Decide on the type of trade you are making
When you decide to enter a trade, you need to decide what type of trade it is. There are three types of trades.
A long position is when you buy shares and hope that the price will rise so you can sell them at an inflated price to profit.
A short position is when you sell shares that you do not own and hope that the price falls so that you can repurchase them at a lower price and make a profit.
When using a spread bet, you bet on the stock price direction without actually owning the stock.
Your position size will be different for each type of trade. For a long position, your position size will be larger than for a short position, as you are risking more money when you are long.
For a spread bet, your position size will be the same for both buying and selling, as you are only betting on the stock price direction.
Decide on your stop loss
A stop loss is an order you place with your broker to sell shares if the price falls below a certain level. It protects you from losing too much money in any one trade.
You will need to decide on a stop loss for every trade you make. It ensures that you always have a plan to protect your profits.
Decide on your target price
A target price is a price you hope to sell your shares to make a profit. It would be best to decide on a target price for every trade that you make. It ensures that you always have a plan to take profits.
Calculate your risk/reward ratio
You can calculate the risk/reward ratio by dividing the amount of money you risk (your risk tolerance) by the amount you could make if the trade is booming.
It is vital to have a risk/reward ratio of at least 1:1, ensuring that you are making a profit on your trades.
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